Fundamentals of Economics (60 Copies)

STUDY NOTE 1
BASIC CONCEPTS OF ECONOMICS
Definition and Scope of Economics:
What is economics?
Economics is one of the social sciences. It explains about the economic activities of a man. Any
activity which is related to earning of the money and spending of the money is called
economic activity. Almost all people are engaged in economic activities, because they want to
earn the money.
Subject Matter of Economics:

In economics, a want is something that is desired. Want is the starting point of economic
activity. Wants leads to efforts. An effort leads to satisfaction.
Wants Efforts Satisfaction
This is the subject matter of economics. This subject matter of economics is divided into four
parts.
(i) Consumption
(ii) Production
(iii) Exchange
(iv) Distribution
(i) Consumption:
It is an act to use the good or service to satisfy the wants. In economics, Consumption is
typically defined as final purchased by an individual that are not investments of some sort. In
other words when you buy food, clothes, chair, aeroplane tickets, a car, etc., that’s
consumption.
In someone buys a house to live in that should be defined as consumption. If you buy a house
to rent out it to someone else, that should be defined as an investment. Similarly, if you buy a
car to drive, that’s consumption. If you buy a car to use as a taxi for a business, that could be
considered as an investment. In short the reason for the purchase determines whether
something is viewed as on investment or as consumption.
(ii) Production:
In economics, Production involves the creation of goods and services by using resources. It is a
process to change the raw materials into final/finished goods. It is nothing but creation of
utility. To produce anything so many factors are essential. All these factors are classified into
four categories. They are:
(a) Land (b) Labour (c) Capital (d) Organization
(iii) Exchange:
It means change of the goods from one person to another person. Once up on a time goods
are exchanged for goods. It is called “Barter system” To overcome the Inconveniences in the
barter system money was invented. Now the goods are exchanged for money. Price is
essential for the exchange of goods for money.
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Modern Academy, CMA :: Foundation – Fundamentals of Economics and Management
(iv) Distribution:
Distribution means sharing of the income among the factors of production. The total income
which is generated by selling of these goods and services in the market must be distributed
among the factors of production in the form of rent, wages, interest and profits. There are
two types of distribution
(a). Micro distribution
(b). Macro distribution
(a) Micro Distribution:

Micro distribution is nothing but pricing of factors of production. It means it explains how the
price (rent) per a unit of land is determined. In the same way how the price per unit of labour
is determined how the price per unit of capital is determined etc., are discussed.
Ricardian theory of rent, modern theory of rent, different wage theories, Interest theories
profit theories etc are discussed.
(b) Macro Distribution:

Macro distribution means sharing of the total national income among the total factors of
production. It means we came to know whether the income is distributed properly or not
properly among the people in the society.
Modern economists extended the subject matter of economics. They added some other
concepts to the economics. They are:
(v) Employment (vi) Income
(vii) Planning and Economic development (viii) International trade
Definition of Economics:
The definitions of economics can be classified into four categories.

(a) Wealth definitions (b) Welfare definitions
(c) Scarcity definitions (d) Growth definitions
1. Explain about Wealth definition?

Ans: Wealth definitions:
Almost classical economists followed wealth definition. It is mostly associated with J.B. Say
and Adam smith. Adam smith was called “Father of Economics”. The name of book written by
Adam smith is “An enquiry into the nature and causes of Wealth of nations (1776). Adam
Smith delinked the economics from political economy and he explained It in a scientific
manner.
Definitions:
 According to J. B. Say, “Economics is the study of science of wealth.
 According to Adam Smith, “Economics is the science which deals with the wealth”.
 According to the above definitions:-
 Economics explains how the wealth is produced, consumed, exchanged and distributed.
 According to Adam smith man is an economic man.
 Economics is a science of study of wealth only.
 This definition deals with the causes behind the creation of wealth.
 It only considers material wealth.
Criticism:
This definition was criticized by so many philosophers. They are Carlyle, Ruskin, Walras, and
Dickens and others. According to critics, economics is a decimal science, Gospel of Mammon,
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bread and butter science, uncompleted science etc. Wealth is of no use unless it satisfied
human wants. This definition is not of much importance to man and his welfare.
2. Explain about welfare definition?

Ans: Alfred Marshall has given a new definition to economics in 1890 which gave a dignified
status to economics. Marshall has given importance to distribution of wealth rather than
production of wealth. According to Marshall economics is a study of man and his welfare.
Definition:
“Political economy or economics is a study of mankind in the ordinary business of life, it
examines that part of individual and social action which is most closely connected with the
attainment and with the use of the material requisites of well-being. Thus it is on the one side, a
study of wealth and on the other and more important side, a part of the study of man”.
- Alfred Marshall
The economists like A.C Pigou and Edwin cannan have also given the same type of definitions.
According to A.C Pigou “the range of enquiry becomes restricted to that part of social welfare
that can be brought directly or indirectly into relation with the measuring rod of money.”
According to Edwin Cannan. “the aim of political economy is the explanation of the general
causes on which the material welfare of human beings depends”.
Important Features of Welfare Definitions:

1. Marshall assumed that economics must be a science even though it deals with human
behavior.
2. Economics studies only economic aspects of human life. It has no concern with the
political, social and religious aspects of life.
3. Welfare definition considered those human activities which increased welfare.
4. Welfare definition has given importance to man and his welfare. According to Marshall
wealth is only a means for the promotion of human welfare.
Criticisms
Marshall definition was criticized by Robbins in his book “Eassy on the nature and significance
of Economics Science”.
1. According to Marshall Economics is a social science rather than a human science. But
according to critics the laws of economics are applicable to all human beings, therefore
economics should be a human science and not as a social science.
2. Marshall definition deals with only material goods and not given any importance to non-
material goods which are also important for human beings. Therefore this definition was
considered as incomplete.
3. Critics pointed out the quantitative measurement of welfare. Welfare is a subjective
concept and changes according to time, place and persons.
4. According to Marshall, economics deals with those activities of man which promote human
welfare. But the production of alcohol and drugs do not promote human welfare. But
economics deals with production and consumption of all these goods.
5. According to Robbins economic problem arise due to limited resources, but Marshall
definition had not considered the “scarcity of resources”.
3. Explain about scarcity definition or Robbin’s definition?

Ans: Lionel Robbins in his famous book “An essay on the nature and significance of Economic
Science (1932) had given a more scientific definition of economics. According to Robbins
Economics is a study of scarcity and choice.
Definition:
“Economics is the science which studies human behavior as a relationship between ends and
scarce means which have alternative uses.”
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Main Features:
1. Human wants are unlimited:
According to Robbins human wants are unlimited. When one want is satisfied another want
takes its place.
2. Means are scarce:
Although human wants are unlimited, the means or resources which are used to satisfy human
wants are limited. Economic problem arises because all wants cannot be satisfied with limited
resources.
3. Alternative uses of scarce resources;
Resources are not only scarce but they have alternative uses.
For Example: Electricity can be used in homes and in industries. A piece of land can be used to
produce rice or wheat. If a scarce factor is used to satisfy one want, less of it is available for
other wants.
4. Problem of choice:
The economic problem arises mainly because of scarcity of resources and have alternative uses.
So, man has to choose between wants. Thus problem of choice arises.
Superiority of Robbins definition:

1. More Analytical:
Robbins definition includes all human activities whether they promote human welfare or not.
2. Applicable to all societies:
Robbins definition is applicable to all types of societies, as the scarcity of resources is felt by
individuals as well as societies. So that it is universally accepted definition.
3. Neutral between ends:
According to Robbins economics is neutral between ends. Being a positive science it does not
pass value judgments.
Criticism:
Followers of Marshall like Durbin, Fraser, Beveridge and Wooton have criticized Robbins
definition by saying that it lacks human touch and it is personal, neutral and devoid of
normative and ethical element. Some of them criticized as “barren scholasticism” and
“behaviorism”
1. Welfare is inherent in this definition:
Robbins criticized welfare concept of Marshall, and the same was introduced in his own
definition. So the criticism of welfare definition is equally applicable to Robbins scarcity
definition.
2. Cannot be neutral between ends:
Critics pointed out that economics as a social science deals with human behavior and has a
social purpose. Therefore economics cannot be neutral between ends.
3. No distinction between ends and means:
Robbins was criticized on the point that he does not distinguish between ends and means
because means are the source of enjoyment and end is satisfaction. Hence enjoyment and
satisfaction are one and the same.
4. Explain about Growth Definition?

Ans: This Definition was given by J.M. Keynes and P.A. Samuelson. It is mostly associated with
P.A. Samuelson. The name of book written by Samuel son was “Economics - An Introductory
Analysis (1948). In this book he gave a new definition to economics.
Definitions
“Economic is the study of how men and society choose with ‘or’ without use of money to
employ the scarce productive resources that would have alternative uses to produce various
commodities over time for distribution them for consumption now or in future among the
various persons and groups in the society. It Analysis the costs and benefits of improving
pattern or resource” - P.A. Samuelson.
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Main points:
1. Like the scarcity definition it also accepts the unlimited wants and limited resource which
have alternative uses.
2. According to Samuelson, the problem of scarcity of resources not only confined to present
but also to the future. It means he introduced the concept of time element.
3. He also adopted a dynamic approach to the study of economics considering Economic
Growth as an integral part of economics.
4. This definition includes Marshall’s welfare definition and Robbin’s scarcity definition.
Distinguish between Traditional Approach and modern approach relating to scope of

Economics
Traditional • Economics is a social science.

Approach • It studies man’s behaviour as a rational social being.
• It considered as a science of wealth in relation to human welfare.
• Earning and spending of income was considered to be end of all economic
activities.
• Wealth was considered as a means to an end – the end being human welfare.
Modern • An individual, either as a consumer or as a producer, can optimize his goal is an
Approach economic decision.
• The scope of Economics lies in analyzing economic problems and suggesting policy
measures.
• Social problems can thus be explained by abstract theoretical tools or by empirical
methods.
• In classical discussion, Economics is a positive science.
• It seeks to explain what the problem is and how it tends to be solved.
• In modern time it is both a positive and a normative science.
• Economists of today deal economic issues not merely as they are but also as they
should be.
• Welfare economics and growth economics are more normative than positive.
5. Distinguish between micro and macro economics?

Ans: Prof. Ragnar frisch was the first person who developed micro and macro economics in
1933. Micro economics studies the behavior of individual units where as macro economics is
the study of aggregates.
Micro Economics:
The term “Micro Economics” is derived from the Greek word MIKROS, means small or
million the part micro economics studies the economic actions and behavior of individuals
Micro Economics is known as partial analysis.
Definition
According to K.E.Boulding, “Micro economics is the study of particular firms, particular
households, individual prices, wages, incomes, individual industries and particular
commodities”.
According to Shapiro “Micro economics has got relation with small segments of the society”.
Scope of micro economics

Micro economics was popularized by Professor Marshall. Micro economics is based on the
assumption of “full employment” and “Marginal analysis”. The three major fields covered by
micro economics are theory of product pricing, theory of factor pricing and theory of welfare.
Micro economics is also called price theory. Because it explains the pricing of products in
markets as well as in factor markets. It also examines whether the resources are efficiently
allocated to individual consumers and producers in the economy which is related to welfare
economics.
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Scope of Micro Economics
Product pricing Factor pricing Theory of Economic welfare
Theory of distribution
Theory of Theory of
Production Rent Wages Interest Profit
demand and costs
Importance of Micro Economics

1. Micro economics explains the working the free market economy.
2. Micro economic analysis is useful to the government to frame suitable policies to promote
economic efficiently and to achieve economic growth and stability.
3. Micro economics can be used to examine the condition of economic welfare and it suggests
ways and means to bring maximum social welfare.
4. Micro economics is useful in international trade in the determination of exchange rate.
5. Micro economics is helpful in explaining the incidence of tax burden between producers
and sellers on one hand and consumers on the other.
6. Micro economic theory are only mere approximations of real world, there is value in
studying analytical techniques. Not only it is good for the mind, but there is value in studying
the language of economists.
Macro Economics
The term macro is derived from the Greek word “Makros’ which means very big or large.
Macro economics is the study of aggregates like national income, total consumption, total
saving, total investment, total employment etc.
Macro economics was developed by J.M. Keynes.
Definition
“Macro Economics studies national Income, Not individual income, General price level instead
of individual prices and national output instead of individual output” - K.E Boulding.
Scope of Macro Economics

Macro Economics become popular after the publication of J.M.Keynes “General theory of
Employment, Interest and money, “Macro Economics deals with the general price level and its
fluctuations over a period of time instead of dealing with relative prices of goods and services.
Macro Economics studies the causes of inflation and suggest measures to control it. Macro
Economics is also known as Income and Employment theory.
Scope of Macro Economics
Theory of Income, Theory of Economic

Theory of General price
employment Distribution Growth
level and inflation
Theory of consumption Theory of Investment
Theory of fluctuation (or)

Business cycles
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Importance:
1. Macro economics is useful to the Government for formulation and execution of policies to
achieve maximum social benefit.
2. Macro economics helps in understanding the problems of unemployment, inflation etc. and
provides solutions.
3. Micro economics helps to evaluate the overall functioning of an economy.
4. Micro economics identify the problems of business cycles and provide solutions.
5. Macro economics suggests how developing countries can use their resources to maximize
their growth.
6. Macro economics is useful for making international comparisons by examining information
on national income, consumption and saving for different countries.
The different between Micro Economics and Macro Economics

Micro and Macro Economics are interdependent. Both the approaches are important for better
understanding of the problems of the economy. In spite of close relationship between two
branches of economics fundamentally they differ from each other.
Micro Economics Macro Economics

1. The word Micro derived from the Greek 1. The word Macro derived from Greek word
word ‘mikros’ means ‘small. ‘Makros’ means ‘large.
2. Micro economics is the study of individual 2. Macro Economics is the study of economy as
units of the economy. whole.
3. It is known as prise theory 3. It is known as Income and employment
theory.
4. Micro Economics explains price 4. Macro Economics deals with national
determination in both commodity and factor Income, Total employment, Aggregate saving
markets. and investment, general price level and economic
growth.
5. Micro Economics is based on price 5. Macro economics is based on aggregate
mechanism which depends on demand and demand and aggregate supply.
supply.
6. State whether the economics is science or Art?

Ans: To say whether the economics is science or Art. We must know about the terms of
Science and Art.
The term science implies:-
a. A systematic body of knowledge which traces the relationship between cause and effect.
b. Observation of certain facts, systematic collection and classification and analysis of facts
c. Making generalization on the basis of relevant facts and formulating laws or theories
there by.
d. Subjecting the theories to the test of real world observations.
e. Like the physics chemistry and botany economics also satisfy the above four
characteristics. Economics is regard as science.
Economics as an Art:
Keynes defines Art as ‘a system of rules for the attainment of a given end”. The object of Art is
to formulate rules to be used for the formulation of policies.
Difference between science and Art:

a. Science is theoretical but art is practical.
b. A science teaches us “to know”, an Art teaches us “to do”.
c. Economics as a science in methodology and Art in its application.
7. State whether the economics is positive or normative science?

Ans:
a). The positive science explains “what it is” but not “what ought to be”
b). It explains about the things as they are
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c). It does not deal with value judgments.
d). According to Lionel Robbins economics is a Positive science.
Economics as a Normative Science:

a) A normative science explains what ought to be and what not ought to be.
b) It relates to value judgments.
c) It deals with good & bad (or) right and wrong.
d) According to Alfred Marshall economics is a normative science.
NOTE: Economics has both the features of positive science and normative science. Hence
economics is both positive and normative.
8. Distinguish between Deductive method and Inductive method?

Ans:
Economists used two methods for conducting economic investigations. They are
1. Deductive method
2. Inductive method
1. Deductive method:
This method is also known as prior method or abstract method or analytical method. This
method is strongly supported by classical economists. The deductive method proceeds from
“general to particular”. This method of reasoning tries to deduce conclusions from certain
fundamental assumptions or truths established and handed over from generation to generation.
Ex: Law of Diminishing Marginal Utility
There are four steps involved in drawing inference through deductive method. They are
1. Selecting the problem
2. Formulating assumptions
3. Formulating the hypothesis
4. Verifying the hypothesis
Deductive method has several advantages. They are
1. It is less expensive and less time consuming.
2. It helps in laying down basic principles of human behavior.
3. It analyses complex economic phenomena and brings exactness to economic
generalizations.
Deductive method has its own defects i.e. it is based on unrealistic assumptions with little
empirical content.
2. Inductive method
Inductive method is also known as historical, empirical, concrete, ethical or realistic method.
This method proceeds from particular to general i.e. it refers to a process where facts are
collected, arranged and their general conclusions are derived.
Ex: The law of diminishing returns, The Malthusian theory of population.
There are four steps involved in deriving economic generalizations through this method. They
are:
1. Selection of the problem
2. Collection of data
3. Observations
4. Generalization.
Inductive method is regarded as realistic method and it has some advantages.
1. It is nearer to reality
2. Less chances of mistakes
In spite of the advantages, it has some limitations.

1. This method is expensive and time consuming
2. It can only be used by those who possess skill and competence in handling complex data.
9. Explain about the central problems of all economies?

Ans: Due to the scarcity of resources every economy should faces some problems. The central
problems of all economics are explained as follows:
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What to produce?
If the present is given importance the resources are diverted for the production of
consumer goods. If future is given importance resources are diverted for the production of
capital goods.
How to produce?
This problem is arising because of unavailability of some resources. A country may
produce by labour Intensive technique ‘or’ capital Intensive technique, depending upon its
man power and stock of capital.
For whom to produce?

A country may produce mass consumption goods at a large (for poor people) ‘or’ goods
for upper classes. It is depend upon policies of the government.
Few Fundamental Concepts
10. Define the wealth and its types?

Ans: Wealth:
The stock of goods under the ownership of a person ‘or’ a nation is called wealth.
(a) Personal wealth:
The stock of goods under the ownership of a person is called personal wealth.
For example: houses, buildings, furniture, land, money in cash, company shares, stocks of
other commodities etc., health, goodwill etc. can also be consider to be the parts of Individual
wealth. But in economics only transferable goods are consider as wealth.
(b) National Wealth:

The stock of goods under the ownership of a nation is called national wealth. It includes
the wealth of all the citizens in the country. For example: Natural resources, roads, parks,
bridges, hospitals, public education institutions etc., If the citizen of the country holds a
government bond It is personal wealth. But form the government point of view it is a liability.
So, it should not be considered the part of wealth of nation.
11. Explain the relationship between wealth and welfare?

Ans: Wealth and welfare:
Welfare means well-being ‘or’ happiness. In generally, If the wealth increases welfare also
increase but…..
1. If a nation goes on creating wealth without paying any consideration to the health and
mental peace of citizens it is doubtful whether the welfare increases.
2. If the wealth is not distributed properly, It is also doubtful whether welfare increases.
12. What is money and state its constituents?
Ans: Money:
Anything which is widely accepted in exchange of goods or in settling debts is regard as
money. Once upon a time Barter system was prevailed.
When some commodities used as a medium of exchange by custom. It is called customary

money.
For example: The use of cowries in ancient India as a medium of exchange.
Constituents of Money Supply:

a). Rupee notes and coins at the public
b). Credit cards
c). Travelers cheques
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13. Define the market and explain its functions?
Ans: Market:
In ordinary language the term market refers to a place where the goods are bought and
sold. But in economics it refers to a system by which the buyers and sellers established
contact with each other directly ‘or’ indirectly with a view to purchasing and selling the
commodity.
Function of the Market:

1. To determine the price of the goods.
2. To determine the quantity of goods [supply]
Market Mechanism:
Market Mechanism means the totality of all markets i.e. the markets for all goods and
services in the market. The market mechanism determines the prices and quantities bought
and sold of all the goods and services.
14. What is meant by investment and its types?
Ans: Investment: An increasing the capital stock is called Investment.

Types of Investment:
(a) Real Investment:
An increasing the real capital stock is called real investment. For example machines, raw
material, buildings and other types of capital goods.
(b) Portfolio Investment:

The purchasing of new shares of a company is called portfolio investment.
Note: Purchasing of an existing share from another share holder is not an investment.
Because it cannot increase the capital stock of the company.
It is savings that are invested:
Y=C+S
(or)
Y =C + I
S=I
• Note: if there is foreign investment then S≠ I.

Gross Investment and Net Investment:
The Aggregate Investment made by an economy during a year is called gross investment.
The gross investment includes.
(a) Inventory Investment:
Investment in raw materials, semi finished goods and finished goods are called inventory
investment.
(b) Fixed Investment:
Investment made in fixed assets like machines, building, factories shares etc. is called
fixed investment.
Net Investment:
By deducting the depreciation cost of capital from gross investment the net investment can be
obtained.
Net Investment = Gross Investment – Depreciation
15. What is production and what are the factors of production?

Ans: Production:
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It refers to creation of goods for the purpose of selling them into the market. In one
word production means ‘Creation of utility”. When a child make a doll for playing for her
enjoyment of this activity, it is not called production but the doll maker who sells these dolls
in the market is engaged in production.
Factors of production:
The goods and services with the help of which the process of production is carried out are
called factors of production. Total factors of production are classified in to four categories.
They are….
1. Land
2. Labour
3. Capital
4. Organization
The factors of production are also called Inputs. The goods and services produced with
the help of Inputs are called output.
16. What is consumption and its determination?

Ans: Consumption:
Consumption is defined as the satisfaction of human wants through the use of goods and
services.
Determinants of consumption:
1. Present Income
2. Future income
3. Wealth income
17. Relationship between income and wealth?

Ans:Income:
The net inflow of money (purchasing power) of a person over a certain period of time is called
income
For example: Daily income, weekly income, monthly income and yearly income.
Wealth and Income:

A person (‘or’ a nation) consumes a part of income and saves the rest. These savings are
accumulated in the form of wealth. Wealth is a stock owned at a point of time. Income is a
flow, over a period of time.
18. Explain about consumer’s surplus?

Ans:The concept of consumer surplus:
This concept was introduced by Alfred Marshall. This concept is derived from law of
diminishing marginal utility. Consumer surplus is the difference between willing price and
actual price.
C.S. = Willing Price – Actual Price

Or
C.S = Demand Price – Market Price.
19. Explain about the law of Diminishing marginal utility.

Ans:Law of diminishing marginal utility:
The law of D.M.U explains the common experience of every consumer. It is based
upon one of the characteristics of wants i.e. “A particular want is satiable”. According to this
law when a person goes on increasing the consumption of any one commodity, the additional
utility derived from the additional unit goes on diminishing. So, it is called law of diminishing
marginal utility. The law of D.M.U was firstly profounded by H.H. Gossan in 1854. So, it is
called Gossans’ first law of consumption. The law of D.M.U was developed by Alfred Marshall.
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Definition:
“The additional benefit which a person derives from a given increase his stock of anything,
diminishes with every increase in the stock that he already has”. – Marshall
Concepts in this law:

1. Total utility:
It is the total amount of satisfaction obtained by the consumer by the consumption of
total units of a thing. The sum of marginal utilities is also called total utility.
TUx = f[Qx]
Or
TUx = ΣMUx
2. Marginal Utility:
It is the additional utility obtained by the consumer by the consumption of additional unit
of a thing ‘or’ one more unit of a thing. The change in the total utility is also called marginal
utility.
∆𝑇𝑈
𝑀𝑈𝑥 =
∆𝑄
Or
𝑀𝑈𝑛 = 𝑇𝑈𝑛 − 𝑇𝑈𝑛−1
Table - Explanation: The law of D.M.U can be explained by the following table
Units Total Marginal

utility utility
1 40 40
2 70 30
3 90 20
4 100 10
5 100 0
6 90 -10
Diagrammatic Explanation:
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Main Points:
a. When total utility Increases, then the Marginal utility diminishing. So, T.U. Curve is
upwards left to right and M.U curve slope downwards from left to right.
b. When the total utility reached the maximum, then the marginal utility is zero. At this point
T.U curve reached the peak stage and M.U curve intercepts ‘X’ axis.
c. When the total utility goes on diminishing then the M.U becomes negative. So, the T.U
curves slopes downwards and M.U curve crossed the x-axis.
Assumptions:
a. The units are Homogeneous.
b. The units must be reasonable size.
c. There is a no time gap between one unit of consumption and other unit of consumption.
d. There is no change in the taste, preferences of consumer.
Exceptions:
a. Collection of the rare goods.
b. Hobbies
c. Misers
d. Money and gold
e. Reading ‘or’ books
Importance:
a. Value paradox
b. Basis for economic laws
c. Finance Minister
d. Re-distribution of wealth
Demand Forecasting:
20. What is demand forecasting and state its methods?

Ans: The success of the business firm depends upon the successful demand foresting.
Estimation of future demand for product at present is called demand forecasting.
Methods of Demand forecasting:

1. Expert opinion method
2. Survey of buyers intensions
3. Collective opinion method
4. Controlled experiments
5. Statistical method.
1. Expert Opinion Method –

Experts or specialists in the fields are consulted for their opinion regarding future demand
for a particular commodity.
2. Survey of buyers intentions –

Generally a limited number of buyers choice and preference are surveyed and on the basis
of that, the business man forms an idea about future demand for the product it is going to
produce.
3. Collective opinion method –

The firm seeks opinion of retailers and wholesalers in their respective territories with a
view to estimate expected sales.
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4. Controlled experiments –
The firm takes into account certain factors that affect demand like price, advertisement,
packaging. On the basis of these determinants of demand the firm makes an estimate about
future demand.
5. Statistical methods –
More often firms make statistical calculations about the trend of future demand.
Statistical method comprising trend projection method, least squares method, progression
analysis etc. are used depending upon the availability of statistical data.
21. Explain about Production Possibility Curve?

Ans: Production Possibility Curve (PPC):
The PPC is also called production possibility frontier, production possibility boundary and
production transformation curve. The PPC curve shows the various combinations of two
commodities that can be produced by an economy with the given resources and given
technology.
Main points:
a. The PPC curve always slopes downwards form left to right. Because when the production
of one commodity is increased, the production of another commodity will be foregone.
b. It is concave to the origin because MRT goes on increasing.
c. The slope of the PPC at any given point is called Marginal rate of transformation (MRT).
The slope defines the rate at which production of one good can be redirected into
production of other. It is also called opportunity cost.
Diagram:
Note:
 If the PPC curve is straight line, the opportunity cost is constant.
 All the combinations which lie on the PPC curve are possible combinations.
 The points beyond the PPC curve are impossible combinations.
 Shift of the PPC curve is nothing but economic growth.
 Any point which lies below the PPC curve is possible combination. But if the economy is
working below the PPC curve that indicates the unused resources ‘or’ unemployment.
Choose the correct answer:
1. Who was the father of Economics?

(a) Marshall (b) Adam smith (c) Robbins (d) Keynes
14
2. Normative Economic theory deals with …..
(a) What to produce (b) How to produce
(c) Whom to produce (d) How the problem should be solved
3. Cetris peribus means
(a) Demand constant (b) supply constant
(c) Other thing being constant (d) none
4. Micro Economics theory deals with.
(a) Economy as a whole (b) Individual units
(c) Economic growth (d) all the above
5. In economics goods includes material things which …
(a) A can be transferred (b) can be visible (c) both A & B (d) None of
the above
6. Human wants are
(a) limited (b) unlimited (c) undefined (d) none of the above
7. Nature of PPF curve is ….
(a) convex to the origin (b) concave to the origin (c) both (d) None of
the above
8. If PPF is linear it implies …
(a) constant opportunity cost (b) diminishing apart cost
(c) Increasing opportunity cost (d) none
9. Any point beyond PPF is ….
(a) attainable (b) unattainable (c) both (d) none of the above
10. If an economy is working at the point left to PPF curve that shows…
(a) Full employment (b) unemployment
(c) Excess production (d) none of the above
11. The Growth definition of Economics was introduced by
(a) J.M. Keynes and P.A. Samuelson (b) Adam Smith
(c) Alfred Marshall (d) Lionel Robbins
12. ______________ defined economics as a science which deals with wealth.
(a) J.B. Say (b) A.C. Pigou
(c) Alfred Marshall (d) Lionel Robbins
13. _____________ goods are known as scarce goods.
(a) Economic (b) Durable
(c) Free (d) Consumer
14. ____________ is the first Law of Consumption.
(a)The Law of Diminishing Marginal Utility (b) The Law of Demand
(c) The Law of Increasing Returns (d) All of the above
15. The ‘Welfare definition’ of Economics was introduced by ___________________
(a) Adam Smith (b) Alfred Marshall
(c) Lionel Robbins (d) J.R. Hicks
16. Micro-economics deals with the _________________
(a) Economic behavior of the Individual (b) Economy as a whole
(c)Trade relations (d) Economic growth of the society
17. Point Elasticity was propounded by ________________
(a) Alfred Marshall (b) Adam Smith
(c) Lionel Robbins (d) Jacob Viner
18. ____________ is an act to use the goods or service to satisfy the wants.
(a) Production (b) Consumption
(c) Savings (d) Distribution
19. Wealth was defined by
(c) Robbins (d) Jacob
20. Income minus Savings is equal to ____________
(a) Consumption (b) Production
(c) Investment (d) Demand
15
21. Scarcity definition was given by _____________
(a) Adam Smith (b) Alfred Marshall
(c) Robbins (d) Samuelson
22. Human wants are
(a) Limited (b) Unlimited
(c) Undefined (d) None
23. All economic questions arise from the fact that
(a) Inflation is inevitable (b) Both wants and resources are unlimited
(c) Unemployment is inevitable (d) Resources are scarce
24. Economic theory assumes that the goal of firms is to maximize
(a) Sales (b) Total revenue
(c) Profit (d) Price
25. Economic resources are
(a) Unlimited (b) Limited in supply but have alternative uses
(c) Unproductive (d) Limited in supply and use
26. Scarcity of resources leads to
(a) Un-satisfaction of human wants (b) Evaluation of alternative uses of scarce resources
(c) Both (d) None
27. Cetris Paribus means
(a) holding demand constant (b) holding supply constant
(c) price being constant (d) other thing being constant
28. The famous book “An enquiry into the nature and causes of wealth of Nation” was
published in-
(a) 1776 (b) 1750
(c) 1850 (d) 1886
29. Economic problems arise because:
(a) wants are unlimited (b) resources are scarce
(c) scare resources have alternative uses (d) all of the above
30. In economics the ‘Utility’ and ‘Usefulness’ have
(a) same meaning (b) different meaning
(c) opposite meaning (d) none of the above
31. Who among the following is not a classical economist?
(a) John maynard Keynes (b) Thomas Malthus
(c) John Stuart mill (d) David Ricardo
32. The terms “Micro Economics” and “Macro Economics” were coined by
(a) Alfred Marshall (b) Ragner Nurkse
(c) Ragner Frisch (d) J.M. Keynes
33. What kinds of economics explain the phenomenon of cause and effect relation?
(a) Normative (b) Positive
(c) Micro (d) Macro
34. Who said economics is the study of choice making decision-
(a) robbins (b) walker
(c) pigou (d) Ricardo
35. Business economics is _________________________ for accurate decision
(a) An ideal science (b) An physical science
(c) An art (d) A science
State the whether the statements are true or false
1. According to Adam Smith man is economic man ( )

2. According to Marshall Economics is normative science ( )
3. Positive science related with J.B. Say ( )
4. The terms micro & macro are introduced by Ragnar Frisch ( )
5. Science is practical, but Art is theoretical ( )
16
6. Positive science does not related to value judgments ( )
7. Gross investment = net investment + depreciation ( )
8. Consumption depends not only on present income but also future income ( )
9. Value paradox was depicted by law of demand ( )
10. PPC is also called PPF ( )
11. All economic goods are called as wants
12. Macro-economics studies the economy as a single unit.
13. Human wants are unlimited
14. Comfort goods are more elastic demand
Match the following:
1. Principles of economics () A). Analytical method

2. Wealth of nations () B). Price theory
3. An essay on the nature and
significance of economic science () C). Historical method
4. Economics an introductory analysis () D). Marshall
5. Micro Economics () E). MRT
6. Macro Economics () F). Production
7. Deductive method () G). Adam smith
8. Inductive method () H). P.A. Samuel son
9. Opportunity Cost () I). J.H. Keynes.
10. Creation of utility () J). Robbins
wealth just in one (or) two sentences

Define
Ans: The stock of goods under the ownership of a person ‘or’ a nation is called wealth.
There are two types of wealth i.e.
1. Personnel wealth: Example: houses, buildings, furniture, cars etc.
2. National wealth: Example: natural resources, roads, parks, bridges etc.
2. What is money?
Ans: Anything which is wide accepted in exchange of goods or in settling debts is regard as
money. Once upon a time Barter system was prevailed.
3. Market
Ans:In ordinary language the term market refers to a place where the goods are bought and
sold. But in economics it refers to a system by which the buyers and sellers established
contact with each other directly ‘or’ indirectly with a view to purchasing and selling the
commodity.
4. Real Investment
Ans: An increasing the real capital stock is called real investment. For example machines, raw
material, buildings and other types of capital goods.
5. Portfolio Investment
Ans: The purchasing of new shares of a company is called portfolio investment.
Production
Ans: It refers to creation of goods for the purpose of selling them into the market. In one word
production means ‘Creation of utility”.
17
6. Define Saving
Ans: Saving is defined as income minus consumption. Whatever is left in the hands of an
individual after meeting the consumption expenditure is called saving. Saving is generated out
of current income and also out of past income.
Concept of consumer’s surplus

Ans: This concept was introduced by Alfred Marshall. This concept is derived from law of
diminishing marginal utility. Consumer surplus is the difference between willing price and
actual price.
C.S = willing price – actual price

or
C.S = Demand price – Market price
7. Marginal utility
Ans: It is the additional utility obtained by the consumer by the consumption of additional
unit of a thing ‘or’ one more unit of a thing. The change in the total utility is also called
marginal utility.
∆𝑇𝑈
𝑀𝑈𝑛 =
∆𝑞
(or)
𝑀𝑈𝑁 = 𝑇𝑈𝑛 − 𝑇𝑈𝑛−1
8. Income
Ans: The income of a person means the net inflow of money (or purchasing power) of this
person over a certain period. For instance, on industrial worker’s annual income is his salary
income over the year. A businessman’s annual income is his profit over the year.
ANSWERS
Choose the correct answer:

1. B 2. D 3. C 4. B 5. C 6. B 7. B 8. A 9. B 10. B
Fill in the blanks:
1. J.B. Say 2. Welfare 3. Marshall 4. Neutral 5. Problem of choice

6. Scarcity
7. P.A.Samuel Son 8. Growth 9. General to particular 10. Particular to
general
True (or) False:
1. True 2. True 3. False 4. True 5. False 6. True

7. True 8. True 9. False 10. True
1. D 2. G 3. J 4. H 5. B 6. I 7. A 8. C 9. E 10. F
18
STUDY NOTE 2
THEORY OF DEMAND AND SUPPLY
1. Explain the law of demand and its exceptions?
Ans: Meaning of Demand

In ordinary language demand means ‘desire’. But in economics demand means desire backed
by the purchasing power and willingness to pay the price.
Law of Demand:
It explains the functional relationship between price and quantity demanded. According
to law of demand when all other things remain constant, If the price rises demand is
decreased. If the price falls demand will be increased. It means there is an inverse relationship
between price and demand.
Dx = f [Px].
Demand Schedule:
It shows the various quantities of the goods that are demanded at various levels of prices.
There are two types of demand schedules:
1. Individual Demand Schedule
2. Market Demand Schedule.
1. Individual Demand Schedule:

It shows the various quantities of goods that are demanded by an individual at various
levels of prices in the market.
Price Quantity demanded

5 10
4 20
3 30
2 40
1 50
Individual Demand Curve:

From the demand schedule we can derive demand curve
19
2. Market Demand Schedule:
It show the various quantities of the goods that are demand by all the consumers in the
market at various levels of prices in the market. When the individual demands are added
market demand can be obtained.
Price of Demand
Good ‘x’ A B C Market Demand
( A+B+C)
10 100 150 50 500
8 125 200 60 385
6 175 250 80 505
4 250 300 110 660
2 350 400 150 900
Diagram:
Whether the individual demand curve or market demand curve slopes downwards
from left to right because there is a inverse relationship between price and demand.
Causes for falling nature of DD curve:
There are many reasons for the falling nature of demand curve. Some of the reasons are
explained as follows:
A) Law of diminishing marginal utility:
According to law of diminishing marginal utility when the quantity of good is more the
marginal utility of the commodity will be less. So the consumer demands more goods when
the price is less. That is why, the demand curve slopes downwards from left to right.
B) Substitution effect:
In the case of substitutes if the price of commodity ‘x’ rises relatively to the other good ‘y’ the
consumer will buy less of commodity ‘x’ and buy more of the good ‘y’ which has become
relatively cheaper. This is called substitution effect. So the demand curve slopes downward.
C) Income effect:
The income effect tells that the real income of the consumer rises due to the fall in the price
level. So they purchase more and more goods when the price falls. This is said to be the
income effect.
D) New buyers:
When the price of a commodity decreases the new consumers are attracted to that
commodity because when the price level falls it becomes cheaper good than before. So the
demand will rise with the price falls.
E) Old buyers:
When the price of anything decreases the old buyers purchase more goods than before. So
the demand will be increased. That, is why, the demand curve slopes downward from left to
right.
Exceptions of the Law of Demand:
The law of demand is a general statement stating that price and quantity demanded of a
commodity are inversely related. But in certain situations, more will be demanded at a higher
20
price and less will be demanded at a lower price. In such cases, the demand curve slopes
upward from left to right which is called an exceptional demand curve as shown in the
following diagram.
When price increases from OP to OP1, quantity demanded also increases from OQ to
OQ1. This is contrary to the Law of Demand. The following are the exceptions to the Law of
Demand.
a) Giffen Paradox (Necessary goods):
In the case of necessary goods the law of demand cannot be operated. This is observed by
British economist, the Sir Robert Giffen. He observed in London the low paid workers
purchase more of bread when its price rises. That’s why, this situation is known as Giffen
Paradox.
b) Speculation:
Some times the price of a commodity might be increasing and it is expected to increase still
further. The consumer will buy more of the commodity at the higher price than they did at the
lower price. It is contrary to law of demand.
c) Conspicuous
These are certain goods which are purchases to project the status and prestige of the
consumer. For e.g: expensive cars, diamond jewellery, etc. such goods will be purchased more
at a higher price and less at a lower price.
d) Shares or Speculative market:
It is found that people buy shares of those company whose price is rinsing on the anticipation
that the price will rise further. On the other hand, they buy less shares in case the prices are
falling as they a expect a further fall in price so such shares. Here the law of demand fails to
apply.
e) Bandwagon effect:
Here the consumer demand of a commodity is affected by the taste and preference of the
social class to which he belongs to. If playing golf is fashionable among corporate executive,
then as the price of golf accessories rises, the business man may increase the demand for such
goods to project his position in the society.
f) Illusion:
Sometimes, consumers develop a false idea that a high priced goods will have a better quality
instead of a low priced good. If the price of such a good falls, they feel that it’s quality also
deteriorates and they do not buy, which is contrary to the law of demand.
2. State the determinants of demand?

Ans: Demand function:
The demand function explains the functional relationship between demand for a
commodity and determinants of the demands. This can be explained by the following
equation.
21
Dn = f (Pn, Psc, Y & T)
Dn = Demand for commodity ‘n’
f = functional relationship
Pn = Price of commodity ‘n’
Psc = Prices of substitute and complementary goods.
Y = Income of the consumer.
T = Tastes and preference of the consumer.
Determinants of demand:
The demand for any commodity is depend upon so many factors. These factors are called
determinants of demand. They are:
1. Price of the goods:
The demand for any commodity firstly depends upon its price. When the price rises
demand decreases, when the prices falls demand increases.
2. Prices of the substitute goods:
The demand for any commodity not only depends upon its price but also the prices of its
substitute goods. For example, tea and coffee. Here the demand for tea depends upon price
of the coffee.
3. Prices of the complementary goods:
The demand for a commodity also depends upon the price of its complementary goods.
For example, car and petrol. Here demand for petrol depends upon price of the car.
4. Income of the consumer:
The income of the consumer also influences the demand for a commodity. When the
income rises people purchase the more quantity of goods. When the income falls they
purchase less quantity ofgoods.
5. Tastes and preferences of the consumer:
The tastes and preference of the consumer can also determine the demand for a
commodity. When the tastes are changed, the demand for goods also changed.
6. Population:
When the population is increased, the demand for goods also increases. When the
population decreases demand also decreases.
7. Climate:
The climatic conditions also can influence the demand. In hot climatic conditions cool
drinks are demanded. In rainy season umbrellas are demanded.
3. Mention different types of demand?

Ans: Types of Demand:
There are three types of demands. They are:
1. Price demand
2. Income demand
3. Cross demand
4. Explain about Price Demand.

Ans: Price demand explains the relationship between price of a commodity and demand for
that commodity. There is an inverse relationship between price and demand. So, the price
demand curve slopes downwards from left to right.
Dx = f [Px]
22
5. Explain about income demand?
Ans: Income Demand:
Income demand explains the functional relationship between income of consumer and
demand for goods. Generally if the level of income rises the consumer purchases more of
goods. If the level of income decreases he purchases less quantity goods. It means there is a
direct proportional relationship between income of consumer and demand of goods. So,
normally the income demand curve slopes upwards form left to right.
Dx = f [y]
The income demand curve is in two types:

In case of superior goods ‘or’ normal goods the income demand curve [I.D] slopes
upwards from left to right. Superior goods means ‘best quality goods’.
In the case of Inferior goods the I.D. slopes downwards form left to right inferior
goods means “less quality goods”.
Diagram:
Inferior goods Normal goods/ superior goods
6. Explain about cross demand?

Ans: Cross Demand:
It shows the relationship between price of one commodity and demand for another
commodity. It means the demand for one commodity not only depend upon its price but also
depend upon the prices its substitute goods and complementary goods.
Dx = f [Py]
The cross demand curve is in two types:

It is upwards from left to right in the case of substitute goods and its slope downwards
form left to right in the case of complementary goods.
23
Substitute goods:
If one good is used in the place of other good to satisfy the same want they are called
substitute goods.
Example: tea & coffee, pen & pencil etc.
In the case of substitute goods there is a direct proportion relationship between price of
one commodity and demand for another commodity. So, the crossed demand curve [CD]
In this case upward from left to right .
Complementary goods:
If two ‘or’ more goods are used to satisfy the single want they are called complementary
goods.
Example: Milk, sugar, tea powder etc., are complementary for tea, cement, bricks, iron etc.,
are complementary for construction work. In this case of complementary there is inverse
relationship between price of one commodity and demand for another commodity. So, C.D In
this case slopes downwards from left to right.
Diagram:
Complementary Substitutes
7. Explain about the changes in demand?

Ans: Changes in Demand and Change in Quantity Demand:
If there is a change in the determinants of a demand that leads to the change in demand.
These changes in demand are two types. They are
1. Extension and contraction of demand
2. Increase and decrease of demand
Extension and Contraction of Demand:
When all other things remain constant if there is a change in the price that leads to the
change in demand. These changes in demand are called extension and contraction of demand.
When the price is decreased the demand is extended when the price is increased the demand
is contracted. To explain the extension and contraction of demand a single demand curve is
enough.
24
2. Increase and decrease of demand
When the price is constant. If there is a change in the other determinants that lends to change
in demand. These changes in demand are called “Increase and decrease of demand”. To
explain the increase and decrease of demand single demand curve is not enough. It means
new demand curves are formed.
a) When the demand is increased, the new demand curve is formed towards right to old
demand curve ‘or’ preceding demand curve.
b) In the same way when the demand is decreased the new demand curve is formed
towards left to old demand curve ‘or’ preceding demand curve.
8. Explain the types of elasticity of demand?

Ans: Meaning of Elasticity of demand
Elasticity means sensitiveness ‘or’ responsiveness. Elasticity of Demand means response in
demand. The elasticity of demand explains change in demand due to the change in the
determinants of the demand.
Types of Elasticity of demand

There are three types of elasticity of demand. They are:
a) Price elasticity of demand.
b) Income elasticity of demand
c) Cross elasticity of demand.
9. Explain the types of price of demand?
Ans: Price Elasticity of Demand:
It shows the relationship between proportionate change in the demand and
proportionate change in the price. It means it explains how much change in the price and it
leads to how much change in the demand.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑

𝐸𝑃 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
𝑑𝑞
𝑞
𝐸𝑃 =
𝑑𝑝
𝑝
𝑑𝑞 𝑝
𝐸𝑃 = ×
𝑑𝑝 𝑞
Definition:
“Elasticity of demand in a market great or small according to the demand increases much
‘or’ little for a given fall in the price and diminishes much ‘or’ little for a given rise in the price”
– Marshall
“Elasticity of demand is a degree of responsiveness of demand as a result of change in

price.
– Mrs. John Robinson
25
Types of price elasticity of demand:
There are five types of price elasticity of demand
1. Perfectly elastic demand (Ep= ∞)
2. Perfectly Inelastic demand (Ep = 0)
3. Relatively elastic demand (EP > 1)
4. Relatively Inelastic demand (EP< 1)
5. Unitary elastic demand (EP = 0)
1. Perfectly elastic demand (EP= ∞):

When the price is constant if there is a change in demand it is said to be perfectly elastic
demand. It means the demand may be increase ‘or’ decrease without change in price. Here
the value of EP is infinity.
The demand curve in this case parallel to OX axis>
2. Perfectly Inelastic demand (EP = 0):

When the price is changed if there is no change in the demand it is said to be perfectly
inelastic demand. It means the price may be increase ‘or’ decrease but the demand is
constant Here the value of EP = 0.
The demand curve in this case parallel to OY axis.
3. Relatively elastic demand (ex: luxury goods):

If the proportionate change in demand is more than proportionate change in the price. It is
said to be relatively elastic demand. It means a little change in the price leads to more change
in demand. Here the value of EP is greater than one the demand curve in the case slopes
downward from left to right.
26
4. Relatively Inelastic demand (ex: necessary goods)
If the proportionate change in demand is less than proportionate change in the price. It is
said to be relatively inelastic demand. It means a more change in the price leads to less
change in demand. Here the value of EP is less than one. The demand curve in this case slopes
down wards from left to right. But is steeper than relatively elastic demand.
5. Unitary elastic demand:

If the proportionate change in the demand is equal to the proportionate change in the
price. It is said to be unitary elastic demand. It means the change in the demand and change in
price are same.
Here the value of EP is 1. Generally comfort goods have unitary elastic demand unitary
elastic demand curve also slopes downwards from left to right but it is rectangular Hyperbola.
10. Explain the types of income elasticity of demand?

Ans: It shows the proportionate change in demand and proportionate change in income. It
means it explains how much change in the income and it leads to how much change in
demand.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑

𝐸𝑃 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛𝑐𝑜𝑚𝑒
𝑑𝑞
𝑞
𝐸𝑌 =
𝑑𝑦
𝑦
𝑑𝑞 𝑦
𝐸𝑌 = ×
𝑑𝑦 𝑞
27
Types:
• Perfectly elastic Income demand (𝐸𝑌 = ∞)
• Perfectly Inelastic Income demand (𝐸𝑌 = 0)
• Relatively elastic Income demand (𝐸𝑌 > 1)
• Relatively Inelastic Income demand (𝐸𝑌 < 1)
• Unitary elastic Income demand (𝐸𝑌 = 1)
1. Perfectly elastic Income Demand

When the income is constant if there is a change in the demand. It is said to be perfectly
elastic income demand. It means the demand may be increase ‘or’ decrease without change in
income. Here the value of 𝐸𝑌 is infinity. The demand curve in this case parallel to OX- axis.
2. Perfectly Inelastic Income demand:

When the income is changed if there is no change in the demand it is said to be perfectly
inelastic income demand. It means the income may be increase ‘or’ decrease but the demand
is constant Here the value of 𝐸𝑌 is zero. The demand curve in this case parallel to OY – axis.
3. Relatively elastic Income Demand:

If the proportionate change in the demand is more than proportionate change in income.
It is said to be relatively elastic income demand. It means a little change in the income leads to
more change in demand. Here the value of 𝐸𝑌 is greater than one. The demand curve in this
case slopes downwards from left to right.
4. Relatively Inelastic Income Demand:

If the proportionate change in the demand is less than proportionate change in income. It
is said to be relatively inelastic income demand. It means a more change in the income leads
to less change in demand. Here the value of 𝐸𝑌 is less than one. The demand curve in this case
slopes upwards from left to right.
5. Unitary elastic income demand:

If the proportionate change in the demand is equal to proportionate change in Income. It
is said to be unitary elastic income demand. It means the change in the income and changes in
the demand are same. Here the value of 𝐸𝑌 is one. The demand curve in this case also upward
from left to right.
Cross elasticity of demand:

It shows proportionate change in the demand for one commodity and proportionate
change in the price of other commodity. It means it explains how much change in the price of
one commodity and it leads to how much change in the demand for another commodity.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟𝑔𝑜𝑜𝑑𝑠 ′𝑋′

𝐸𝐶 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 ′𝑦′
𝑑𝑞𝑥
𝑞
𝐸𝑐 = 𝑥
𝑑𝑝𝑦
𝑃𝑦
𝑑𝑞𝑥 𝑃𝑦
𝐸𝑐 = ×
𝑑𝑝𝑦 𝑞𝑥
11. State the method of measurement of Elasticity of demand?

Ans: There are four methods to measure the elasticity of demand. They are:
1. Percentage method
2. Total outlay method
3. Point method
4. Arc method
28
1. Percentage Method:
In this method to measure the elasticity of demand firstly we should find out the change
in demand and change in price in percentages. Then the following formula can be used.
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑

𝐸𝑃 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
2. Total outlay Method:

In this method on the basis of relationship between price and total expenditure Elasticity
can be decided:
 If the total expenditure increases with the falling of the price and decrease with the
raising of the price. It is said to be relatively elastic demand (𝐸𝑃 > 1).
 If the total expenditure is constant even the price increase ‘or’ decrease it is said to be
unitary elastic (𝐸𝑃 =1).
 If the total expenditure decreases with the falling of the price and increase with the
raising of the price. It is said to be relatively in elastic demand (𝐸𝑃 < 1).
Price Demand Total Outlay

9 40 360
8 50 400
7 60 420
6 70 420
5 80 400
4 90 360
3. Point Method:
In this method the elasticity of demand can be measured at a particular point on the
demand curve. In this method the following formula can be used.
𝑙𝑜𝑤𝑒𝑟 𝑠𝑒𝑔𝑚𝑒𝑛𝑡
𝐸𝑝 =
𝑈𝑝𝑝𝑒𝑟 𝑠𝑒𝑔𝑚𝑒𝑛𝑡
Let we assume the total length of the demand curve is 40cm. AB is the demand curve in the
diagram. How the elasticity of demand can be measured on the demand curve is explained in
the following way.
Diagram:
𝑷𝑩 𝟐𝟎
𝑬𝒑 𝒂𝒕 𝒑𝒐𝒊𝒏𝒕 ′𝒑′ = = =𝟏
𝑷𝑨 𝟐𝟎
𝒑𝟏 𝑩 𝟑𝟎
𝑬𝒑 𝒂𝒕 𝒑𝒐𝒊𝒏𝒕 ′𝑷𝟏 ′ = = =𝟑
𝑷𝟏 𝑨 𝟏𝟎
𝒑𝟐 𝑩 𝟏𝟎
𝑬𝒑 𝒂𝒕 𝒑𝒐𝒊𝒏𝒕 ′𝑷𝟐 ′ = = = 𝟎. 𝟑𝟑
𝑷𝟐 𝑨 𝟑𝟎
29
𝒑𝟑 𝑩 𝟒𝟎
𝑬𝒑 𝒂𝒕 𝒑𝒐𝒊𝒏𝒕 ′𝑷𝟑 ′ = = =∞
𝑷𝟑 𝑨 𝟎
𝒑𝟒 𝑩 𝟎
𝑬𝒑 𝒂𝒕 𝒑𝒐𝒊𝒏𝒕 ′𝑷𝟒 ′ = = =𝟎
𝑷𝟒 𝑨 𝟒𝟎
4. Arc Method:
If there are small changes in demand and prices it is not possible to measure the elasticity
of demand by the point method So, the Arc method is introduced. In this method the
following formula can be used.
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

𝐸𝑃 = ÷ 𝑠𝑡
1𝑠𝑡 𝑑𝑒𝑎𝑚𝑛𝑑 + 2 𝑑𝑒𝑚𝑎𝑛𝑑 1 𝑝𝑟𝑖𝑐𝑒 + 2𝑛𝑑 𝑝𝑟𝑖𝑐𝑒
𝑛𝑑
𝑞2 − 𝑞1 𝑝2 − 𝑝1
= ÷
𝑞1 + 𝑞2 𝑝1 + 𝑝2
Price Demand
2 p1 1000 q1
1 p2 2000 q2
1000 −1
÷
1000 + 2000 1 + 2
1000 3
× = −1
3000 −1
= Unitary Elastic Demand
12. State the importance of Elasticity of demand?

Ans: Importance of Elasticity of Demand
The concept of elasticity of demand is of great practical importance in the sphere of
government finance as well as in trade and commerce.
(i) Business Decision:
If the product has more elastic demand the business man fixes the less price, if the good
has less elastic demand he will fix the more price.
(ii) Monopolist:
The monopolist fixes the more price in one market in which the elasticity of demand is
less. And less price in more elastic demand market for the same thing (or) same good.
(iii) Determination of factor price:
The concept of elasticity of demand also helps in determining the price of various factors
of production. Factor having in elastic demand gets higher price and factors having elastic
demand gets lower price.
(iv) Route for international trade:
If demand for exports of a country in inelastic, that country will enjoy a favorable terms of
trade while if the exports are more elastic than imports, then the country will lose in the
terms of trade.
(v) To the government:
The concept of elasticity of demand also enable the government to decide what particular
industries should be declared as ‘public utilities’ to be taken over and operated by the state.
13. State the determinants of Elasticity of demand?

Ans: Determinants of Elasticity of Demand:
(i) Nature of the commodity
(ii) Availability of substitutes
(iii) Variety of uses
(iv) Possibility of postponement of consumption
(v) Durable goods
30
(i) Nature of the commodity:
In the case of necessaries the demand is less elastic (or) comparatively inelastic. For
example rice, salt, pulses, matchbox etc.
On the other hand the elasticity of demand for luxuries is more elastic. For example, TV,
DVD players, Gold, Diamonds etc.
Comfort goods have unitary elastic demand.
(ii) Availability of substitutes:
If a commodity has substitute goods, the elasticity for that commodity is more elastic. For
example, Lux soap, pears soap, ponds and Lakme creams.
(iii) Variety uses:
If the goods have several uses, the elasticity of demand for it is more elastic. For example,
milk, coal, electricity etc.
(iv) Possibility of Postponement of consumption:
There are certain goods which can be postponed for purchase. In case of these goods, the
demand is elastic. But in the case of life saving medicines the demand will be inelastic because
we cannot postpone the purchase of such goods.
(v) Durable goods:
In case of durable goods the elasticity of demand will be less, but in case of perishable goods
the elasticity of demand will be more.
14. What is supply and explain about the law of supply?

Ans: Meaning of supply:
There is a difference between stock of the goods and supply of goods. Supply means some
of the part of stock of the goods which is prepared by a seller to sell at a particular price, at a
particular market in a particular period of time.
Law of supply:
It explains the functional relationship between price of a good and supply of the good.
When all other things remain constant, if the price rises supply also increase, if the price falls
supply will be decrease. It means there is direct proportional relationship between price and
supply.
Sx = f(px)
Supply Schedule:
It shows the various quantities of the goods that are supplied at various levels of prices.
Types of supply schedule:

There are two types of supply schedule. They are
1. Individual supply schedule
2. Market Supply schedule
1. Individual supply schedule:

It shows various quantities of the goods that are supplied by an individual seller (or)
producer at various levels of prices in the market.
Price of x Supply of ‘x’ goods

500 0
1000 10
1500 30
2000 55
2500 90
Supply curve: From the above supply schedule the supply curve can be drawn.
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1. Market Supply schedule:
It shows the various quantities of the goods that are supplied by various producers (or)
sellers at various levels of prices in the market. When we add the supply of all sellers then
total supply ‘or’ market supply can be obtained.
Whether the individual supply curve ‘or’ market supply curve slopes upward from left to
right as there is a direct proportional relationship between price and supply.
Exception to the law of supply:

a) Land (or) Agriculture goods.
In the case of land (or) Agriculture goods supply cannot be changed according the price. So in
the case of land (or) Agriculture goods the supply curve is parallel to OY-axis.
b) Rare goods.
In the case of rare goods supply cannot be changed according the price. So in the case of rare
goods the supply curve is parallel to OY-axis.
c) Supply of labour.
In the case of labour the supply curve is backward bending. Because in the initial stage if the
wage level is increased the supply of the labour also increased. Beyond a certain stage if the
wages are increased they require the more leisure. So the supply of labour will be decreased.
Change in Supply:-
If there is a change in the determinants of the supply that leads to the change in supply.
These changes in supply are two types. They are:
1. Extension and contraction of the supply
2. Increase and decrease of the supply.
1. Extension and contraction of the supply:

When all other things remains constant if there is a change in the price that leads to
change in the supply. These changes in the supply are called extension and contraction of the
supply. When the price is increased the supply will be extended, When the price is decreased
the supply will be contracted. To explain the extension and contraction of the supply a single
supply curve is enough.
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Diagram:
2. Increase and decrease of supply:

When the price is constant if there is a change in any one of the determinants of supply, that
leads to change in supply. These changes in supply are called increase and decrease of supply.
To explain the increase and decrease of the supply a single supply curve is not enough. It
means new supply curves are formed.
 When the supply is increased the new supply curve is formed towards right to the old
supply curve.
 In the same way when the supply is decreased the new supply curve is formed towards
left to the old supply curve.
15. State the types of elasticity of supply?

Ans: Elasticity of supply:
It shows about the proportionate change in the supply and the proportionate change
in price. It means it explains how much change in the price and it leads to how much change in
the supply.
𝒅𝒒
𝑷𝒓𝒐𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒂𝒕𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒔𝒖𝒑𝒑𝒍𝒚 𝒒
𝑬𝟏 = =
𝒑𝒓𝒐𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒂𝒕𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒅𝒑
𝒑
𝒅𝒒 𝒑
= ×
𝒅𝒑 𝒒
Types of elasticity of Supply:

There are five types of Supply elasticity of Supply
1. Perfectly elastic Supply (Es= ∞)
2. Perfectly Inelastic Supply (Es = 0)
3. Relatively elastic Supply (Es > 1)
4. Relatively Inelastic Supply (Es< 1)
5. Unitary elastic Supply (Es = 0)
1. Perfectly elastic Supply (Es= ∞):

When the price is constant if there is a change in Supply it is said to be perfectly elastic
Supply. It means the Supply may be increase ‘or’ decrease without change in price. Here the
value of EP is infinity. The Supply curve in this case parallel to OX axis>
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2. Perfectly Inelastic Supply (Es = 0):
When the price is changed if there is no change in the Supply. It is said to be perfectly
inelastic Supply. It means the price may be increase ‘or’ decrease but the Supply is constant
Here the value of Es = 0. The Supply curve in this case parallel to OY axis.
3. Relatively elastic Supply (Es>1):

If the proportionate change in Supply is more than proportionate change in the price. It is
said to be relatively elastic Supply. It means a little change in the price leads to more change in
Supply. Here the value of Es is greater than one the Supply curve in the case upwards from left
to right.
4. Relatively Inelastic Supply (Es <1)

If the proportionate change in Supply is less than proportionate change in the price. It is
said to be relatively inelastic Supply. It means a more change in the price leads to less change
in Supply. Here the value of Es is less than one. The Supply curve in this case also slopes up
wards from left to right.
5. Unitary elastic Supply:

If the proportionate change in the supply is equal to the proportionate change in the
price. It is said to be unitary elastic supply. It means the change in the supply and change in
price are same. Here the value of Es is 1. Unitary elastic supply curve also slopes upwards from
left to right.
16. State the determinants of supply?

Ans: Supply function:
The supply function explains the relationship between the supply and the factors that
determines the supply. This can be explained through an equation:
Sx = f (Px, Pf, T, W, GP)
In the above equation

Sx = supply of goods ‘x’
f = functional relationship
Px = Price of ‘x’
Pf = Price of inputs (factors)
T = Technology
W = Weather conditions
GP = Government policy
Determinants of supply:
The supply of any commodity is depending upon some factors. They are called
determinants of the supply. They are:
1. Price of the goods:

Price of the goods is main determinant of supply. Producers supply more goods if the
prices are high. They supply the fewer goods when the prices are low.
2. Goals of the firm:
Firms may try to work on various goals for e.g. Profit maximization, sales maximization,
employment maximization. If the objective is to maximize profit, then higher the profit from
the sale of a commodity, the higher will be the quantity supplied by the firm and vice-versa.
3. Inputs Prices:
The producers supply more when the inputs prices are low, that is at lower costs of
production. At higher inputs rises they supply less.
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4. Technology:
New Technology generally helps to save inputs and reduces costs and time to produce the
output. An improved technology enhances the supply of the goods.
5. Government Policies:
Government policy of taxes and subsidies on goods brings about changes in supply, higher
taxes on goods discourage producers and their supply will be less. On the other subsidies from
government encourage producers to supply more.
6. Expectation about future prices:
If the producers expect an increase in the price of a commodity, then they will supply less at
the present price and hoard the stock in order to sell it at a higher price in the near future.
This will be opposite in case if they anticipate fall in future price (e.g. Fruit seller).
7. Prices of the joint commodities:
Usually an increase in the prices of other commodities makes the production of that
commodity whose price has not risen relatively less attractive we thus, expect that other
things remaining the same, the supply of one commodity falls when the price of joint good
rises.
8. Number of firms in the market:

Since the market supply is the sum of the suppliers made by individual firms, hence the
supply varies with changes in the number of firms in the market. A decreases in the number of
firm reduces the supply.
9. Natural factors:
Supply of goods depends on favourable weather conditions. Conditions like drought,
floods, extreme weather, pests and diseases disturb crop production and raw material supply.
This will affect the supply of goods.
17. State the determinants of Elasticity of supply.

Ans: Determine of elasticity of supply:-
1. Nature of the commodity
If the good is durable the elasticity of supply will be more [Es>1], the perishable goods
have less elastic [Es>1]
2. Time factor
In the long period the elasticity of supply will be more [Es>1] in the short period the
elasticity of supply will be less [Es>1]
3. Availability of facilities
If they are more facilities [Es>1] (or) [Es>1]
4. Cost of production
If the cost of production is more the elasticity of supply will be less, if the cost of
production is less [Es>1].
5. Nature of inputs
If the inputs are available in the market there is a more elastic supply otherwise less
elastic supply.
6. Risk taking
If the entrepreneur takes the risks the elasticity of supply will be more otherwise less.
EQUILIBRIUM
Equilibrium:
Equilibrium price means constant price (or) unchanged price. According to classical
economists the price of a good is determined by the combine actions of the buyers and
sellers. It is nothing but demand and supply. The equilibrium price is determined when the
demand and supply are equal. This can be explained by the following diagram.
35
According to the above diagram both demand and supply are equal at oq level. So equilibrium
price is determined as ‘op’. At the price of P1 the supply is more than the demand. At the
Price of P2 the demand is more than supply. So, p1 and p2 are not equilibrium prices.
Equilibrium price means constant price (or) unchanged price. But this equilibrium price also
changed whenever there is a total change in the demand and total change in supply this can
be explained by the following cases.
Case – I
When the supply is constant, and the demand is changed how the price is determined can be
explained as follows:
When supply is constant if the demand is increased equilibrium price also increased. When
the demand is decreased the equilibrium price also decreased.
Case-II
Demand is constant and supply is changed. If the demand is constant if the supply increase
the price will be decreased and if the supply is decreased the price will be increased.
36
Case-III
When both demand and supply are change in the same proportion. When both demand and
supply are increased in same proportion there must be not change in the equilibrium price. In
the same way when both D/s are decreased in same proportion, price also constant.
Case – IV:
When there is a more change in demand and less change in supply. If there is a more increase
in demand and less increase in supply that leads to increase of the price.
Case – V
If there is a more increase in the supply and less increase in the demand that leads to
decrease of the price.
37
Case – VI
When the demand is increased and supply is decreased, the new equilibrium price will be
increased. In the same way when the supply is increased and demand is decreased the
equilibrium price will be decreased.
I. List of the questions

1. Explain the law of demand and its exceptions.
2. State the determinants of demand.
3. Explain about income demand.
4. Explain about cross demand.
5. Explain about the changes in demand.
6. Explain the types of elasticity of demand.
7. Explain the types of price of demand.
8. Explain the types of income elasticity of demand.
9. State the method of measurement of Elasticity of demand.
10. State the importance of Elasticity of demand.
11. State the determinants of Elasticity of demand.
12. What is supply and explain about the law of supply?
13. State the types of elasticity of supply.
14. State the determinants of supply.
15. State the determinants of Elasticity of supply.
II. Give the answer in one/two sentences:
1. Demand function
Ans: The demand function explains relationship between demand for commodity and
determinants of demand.
Dx = f [Px, Psc, Y, T&A]
2. Market demand schedule

Ans: It shows the various quantities of the goods that are demand by all the consumers at
various levels of prices in the market. When the individual demands are added market
demand can be obtained.
3. Giffen goods
Ans: Giffen goods are also called necessary goods. In case of necessary goods the law of
demand is not operated. It was observed Sir Robert Giffen Hence they are called Giffen goods.
4. Conspicuous goods
Ans: These are certain goods which are purchases to project the status and prestige of the
consumer.
For e.g.: expensive cars, diamond jewellery, etc. such goods will be purchased more at a
higher price and less at a lower price.
5. Cross demand
Ans: It shows the relationship between price of one commodity and demand for another
commodity. It means the demand for one commodity not only depend upon price but also
depend upon the prices its substitute goods and complementary goods.
Dx = f [Py].
6. Arc method
Ans: If there are small changes in demand and prices it is not possible to measure the
elasticity of demand by the point method So, then Arc method is introduced. In this method
the following formula can be used.
38
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
𝐸𝑝 = ÷
1𝑠𝑡 𝑑𝑒𝑚𝑎𝑛𝑑 + 2𝑛𝑑 𝑑𝑒𝑚𝑎𝑛𝑑 1𝑠𝑡 𝑝𝑟𝑖𝑐𝑒 + 2𝑛𝑑 𝑝𝑟𝑖𝑐𝑒
𝑞2 − 𝑞1 𝑃2 − 𝑃1
÷
𝑞1 + 𝑞2 𝑃1 + 𝑃2
7. Contraction of demand
Ans: When all other things remain constant if there is an increase in the price that leads to
decrease in demand. It is said to be contraction of demand.
8. Supply
Ans: There is a difference between stock of the goods and supply of goods. Supply means
some of the part of stock of the goods which is prepared by a seller to sell at a particular price,
at a particular market in a particular period of time.
9. Supply function
Ans: It explains the relationship between supply of the commodity and determinants of the
supply.
Sx = f [Px , P0 , Pf, T & G]
10. Supply of labour

Ans: In the case of labour the supply curve is backward bending. Because in the initial stage if
the wage level is increased the supply of the labour also increased. Beyond a certain stage if
the wages are increased they require the more leisure. So the supply of labour will be
decreased.
III. Choose the correct answer:

1. Point elasticity was propounded by
(a) Adam smith (b) Marshall (c) Robbins (d) Keynes
2. Luxury goods have ____ degree of elasticity
(a) High (b) low (c) Moderate (d) none
3. The demand for salt is inelastic, because
(a) of low price (b) absence of it makes food tasteless
(c) no substitutes (d) All the three
4. Price electricity demand of product will be more elastic if it
(a) has no substitutes (b) has number of substitutes
(c) is an item of necessity (d) is life saving product
5. If the price of burger rises for Rs. 12 per piece to Rs. 20 per piece as a result of which the
daily sales decrease from 300 to 200 pieces per day. The price elasticity of demand can be
estimated as
(a) 0.5 (b) 0.8 (c) 0.25 (d) 2.10
6. An increase in price will result in an increase in total revenue if
(a) percentage change in quantity demanded in greater than the percentage change in price
(b) percentage change in quantity demanded is less than the percentage change in price
(c) percentage change in quantity demanded is equal to the percentage change in price
(d) none
7. If the price elasticity of demand for wine is estimated to be -0.6, then a 20% increase in
price of wine will lead to …….. in quantity demanded of wine at that price
(a) 12% increase (b) 12% decrease (c) 19.6% increase (d) 20.6% decrease
8. Which of the following is not a factor in market supply of a product

(a) cost of production (b) number of buyers
(c) market price of the product (d) price of related products
9. Which of these will have highly inelastic supply
(a) perishable goods (b) consumer durables goods
(c) Items of elite class consumption (d) All
39
10. The supply function of a product x is as Sx = 5px+3. Where px stand for price. The quantity
supplied corresponding to price of ` 2 will be ………
(a) 18 (b) 13 (c) 15 (d) 23
11. According to the ‘Law of Demand, demand varies ______________ with price.
(a) Directly (b)Indirectly (c) Proportionately (d) Inversely
12. When excess demand occurs in an unregulated market, there is a tendency for:
(a) Price to rise (b) Quantity Supplied to decrease
(c) Quantity demanded to increase (d) price to fall
13. In the case of inferior goods, the consumer
(a) Purchases less with increase in income (b) Purchases less with decrease in price
(c) Purchases more with increase in income (d) Purchases more with decrease in price
14. When two or more different goods are produced together by a single firm, it is called as ---
----------- supply.
(a) Joint (b) Composite (c) Excess (d) Short
15. The supply curve always slopes _____________
(a) Upwards (b) Downwards (c) both (A) and (B) (d) neither (a) nor (B)
16. When the price of a complementary product falls, the demand for the other product will _
(a) Fall (b) Increase (c) Remain stable (d) Drop by 25 percent
17. If the proportionate change in the supply is equal to the proportionate change in the price,
it is said to be ______________ supply.
(a) Unitary elastic (b) Perfectly inelastic
(c) Perfectly elastic (d) Relatively inelastic
18. __________ refers to the quantity of a commodity which a firm is willing to produce and
offer for sale.
(a) Individual Supply (b) Market Supply
(c) Individual Demand (d) Market Demand
19. The Law of Diminishing Marginal utility was developed by _____
(a) Stanley Jevons (b) Alfred Marshall (c) Adam Smith (d) J.R. Hicks
20. __________ demand is also known as Direct Demand.
(a) Derived (b) Autonomous (c) Individual (d) Consumption
21. Total Outlay Method of measuring Elasticity of Demand was introduced by ______
(a) Stanley Jevons (b) Alfred Marshall (c) Adam smith (d) J R Hicks
22. ___________ means the desire backed by the necessary purchasing power.
(a) Consumption (b) Production (c) Investment (d) Demand
23. Law of demand, there is a _________ relationship between price and demand
(a) Inverse (b) How to produce
24. __________ tells us the rate of change in demand
(a) Elasticity of demand (b) Consumption analysis
(c) Demand analysis (d) Consumer surplus
25. Cross elasticity of unrelated products will be
(a) Infinite (b) Zero (c) >1 (d) <1
26. If the demand for a good is inelastic, an increase in its price will cause the total
expenditure of the consumers of the good to:
(a) Increase (b) Decrease (c) Remain the same (d) Become Zero
27. Price and demand are positively correlated in case of
(a) Normal goods (b) Comforts (c) Giffen goods (d) Luxuries
28. When price elasticity of demand for normal goods is calculated, the value is always:
(a) Positive (b) Negative (c) Constant (d) Greater than 1
29. Income elasticity of demand for normal goods is always:
(a) 1 (b) Negative (c) More than1 (d) Positive
30. Positive income elasticity implies that as income rises, demand for the commodity:
(a) Rises (b) Falls (c) Remains unchanged (d) Becomes Zero
31. When Marginal Utility is zero, total Utility is:
(a) Minimum (b) Maximum (c) Law of return (d) None of the above
40
32. The horizontal demand curve parallel to x-axis implies that the elasticity of demand is:
(a) Zero (b) Infinite (c) Equal to one (d) Greater than Zero but less than infinity
33. The supply of a good refers to:
(a) Stock available for sale (b) Total stock in the warehouse
(c) Actual Production of the good
(d) Quantity of the good offered for sale at a particular price per unit of time.
34. Demand for a commodity refers to:
(a) Need for the commodity (b) Desire for the commodity
(c) Amount of the commodity demanded at a particular price and at a particular time
(d) Quantity demanded of that commodity
35. If cross elasticity of demand=0, it means that goods are
(a) Perfect complementary (b) Perfect substitute goods
(c) Unrelated goods (d) None of these
36. If the demand for a product reduces by 2% as a result of an increase in the price by 10%,
what is the piece elasticity of demand for the product?
(a) 0.20 (b)-0.40 (c) -0.20 (d) 0.40
37. Which of the following would result in the shifting of the demand curve?
(a) Increase in the tax on shoes (b) Growth in the size of population
(c) Change in weather conditions (d) All of the above
38. A downward sloping Income curve shows –
(a) Normal goods (b) inferior goods (c) Substitute goods
(d) Complementary goods
39. Change in demand, as a result of the factors other than price is known as-
(a) Demand fluctuation (b) Contraction/extension of demand
(c) Demand Shrinking (d) Shift in demand
V. State the sentence true or false

1. In ordinary language demand means desire ( )
2. There is a inverse relationship between income and demand ( )
3. Consumers tastes can influence the demand ( )
4. Change in the demand due to the change in price is called extension of demand ( )
5. In case of exception of law of demand of the price demand curve slopes downwards from
left to right ( )
6. Comfort goods have more elastic demand ( )
7. Price discrimination is possible due to elasticity ( )
8. The supply curve in case of land is parallel to x-axis ( )
9. If there is more increase in demand and less increase in supply, then quantity and price
rises ( )
10. If there is more decrease in supply and less decrease in demand then quantity decrease
and price rises ( )
11. Law of Supply explains the functional relationship between the supply of goods and the
demand for goods.
12. The Price Demand curve slopes downwards from left to right.
13. Value of Paradox is depicted by law of demand.
14. Perfectly Elastic Demand Curve is parallel to ‘X’ axis.
15. Perfectly Elastic Supply Curve is parallel to ”X” axis.
16. The supply curve in case of land is parallel to X-axis.
17. In ordinary language demand means desire.
18. An increase in price will cause a demand curve to shift to the right.
41
VI. Match the following
A B
1. law of demand () A. income demand
2. substitution effect () B. movement on DD curve
3. superior goods () C. Time factor
4. Contraction of demand () D. inelastic demand
5. Decrease in demand () E. demand curve
6. Durable goods () F. elasticity of demand
7. Unitary elastic DD curve () G. Rectangular hyperbola
8. Business decision () H. government policy
9. Supply () I. Marshall
10. Elasticity of supply () J. shift of DD curve
Key
(III) Choose the correct answer
1. (b) 2. (a) 3. (c) 4. (b) 5. (a) 6. (b) 7. (b) 8. (b) 9. (a) 10. (b)
(IV) Fill in the blanks

1. Inverse 2. Complementary goods 3. Decreases 4. Shift 5. Total expenditure
6. More 7. Less 8. Backward bending 9. Unlimited 10. parallel to ox-axis
(V) True (or) False

1. (T) 2. (F) 3. (T) 4. (T) 5. (F) 6. (F) 7. (T) 8. (F) 9. (T) 10. (T)
(VI) Match the following.

1. (I) 2. (E) 3. (A) 4. (B) 5. (J) 6. (D) 7. (G) 8. (F) 9. (H) 10. (C)
42
STUDY NOTE 3
THEORY OF PRODUCTION
1. What is a production function?

Ans: Production function explain the relationship between the physical inputs and physical
output of a firm for a given state of technology. The production-function is a purely technical
relation that connects factor-inputs and outputs.
The production-function can be written mathematically as follows:

Qx = f (F1, F2, F3………. Fn)
Here, qx = the quantity of x commodity
F1, F2, F3………. FN = different factor-inputs.
This equation tells that the output of x depends on the factor F1, F2, F3………. Fn, etc,
There is functional relationship between factor-inputs and the amount of goods x.
2. What are the types of production function?

Ans: Types of production function:
Before analyzing the types of production-function it will be useful to understand the
meaning of following important terms :
1. Short period production functions:

It shows the relationship between production and factors of production in the short
period. In the short period all factors may not be available, so the factors of production in the
short period can be divided into two types they are:-
a. Fixed factors
b. Variable factors
a. Fixed factors:
The factors which are not available in the short period they can be kept as constant. So
they are called fixed factors.
Example: land, building, machines etc.
b. Variable factors:
The factors which are available to change the output in the short period, they can be
changed so they are called variable factors
Example: capital, labour, raw materials etc.
2. Long period production function:

It explains the relationship between production and factors of production in the long
period. It is also called as law of return to scale.
Note: The classification of fixed and variable factors is related to only short period. But in long
period all factors are variable factors.
3. What is land and explain the features of land?

Ans: Land:
Land in common usage is soil or surface of the earth. As a factor of production it refers to
all natural resources like forests, water, climate, minerals etc. It mainly supplies food to
people, provides space for work and supplies raw material to industry.
Land has certain peculiar features:
43
1. Gift of nature:
Land is a gift of nature. Location of land deposits of minerals at certain places. Climatic
conditions are no doubt gift of nature.
2. Limited in supply:
The total geographical area of a country remains the same. In fact certain resources like
oil, gas, coal and some species of wild life may not be available after some time.
3. Immobile factor:
Land cannot be moved from one place to another like other factors. However its ownership
can be transferred and its use can be shifted from one crop to another crop.
4. Diminishing returns:
Early economists held the view that land is subject to the law of diminishing returns.
Increased use of capital and labour on any given quantity of land would give us diminishing
returns.
5. Land differs in fertility:
There will be differences in fertility of land. As a result, the output changes from one plot
to the other. It is because of these peculiarities of land, the early economists considered land
as a separate factor of production.
4. What is Labour and explain the features of labour?

Ans: Labour
In the ordinary usage, labour stands for only physical labour. In economics, labour means
physical as well as mental services engaged in production to earn income. Classical economists
and Karl Marx have considered labour as the sole factor of production.
Features of Labour:
Labour as a factor of production possesses certain peculiar features:
1. Labour is inseparable:
Labour is inseparable from labourer but in the case of other factors i.e. land and capital
are separable from land lord and capitalist.
2. Labour is perishable:
If a worker does not find work on a particular day, the labour is lost for that day. Like
other factors of production, labour cannot be preserved.
3. Supply of labour:
Labourers offer more labour at lower wages. When wages rise beyond a certain level they
prefer to enjoy leisure and supply less labour. It is observed that supply curve of labour is
backward bending at higher wages.
4. Weak-bargaining power:
Labour has less bargaining power as it is a perishable thing. In the same way the trade
unions are not strengthened so they cannot fight for better wages.
5. Differ in efficiency of labour:
Some labourers have more efficiency and some labourers have less efficiency.
5. What is Capital and explain the functions of capital?

Ans: Capital:
In the ordinary sense capital means money for an individual or a firm. Money is a form of
capital when it is used to purchase machinery, tools, raw materials etc. Ultimately it is these
man made goods i.e. Machinery, tools etc. that help in the production of goods. These are
vital in raising productivity in different sectors.
Functions of capital:
Capital performs certain important functions in production.
1. Capital supplies tools and machines:
44
Capital supplies tools and machines that assist the labourers in working efficiently and
producing more output. A labourer backed by better tools and machines will be more efficient
in production.
2. Improves productivity of labourer:
Capital improves per capita productivity of labourer. This in turn increases the overall
production.
3. Capital supplies raw materials:
Capital supplies raw materials, supply of raw material on continuous basis is required in
production.
4. Generate more employment:
Additional tools and machines generate more employment to people. However in the modern
production labour replacing machines reduce employment opportunities.
5. Provides transport facilities:
Capital in the form of roadways, railways, ships help to transport raw material to the site of
the production and finished goods to the market.
6. What is and Organization explain the functions of Organization?

Ans: Entrepreneur:
The person who organizes the production is called an entrepreneur. He is considered as a
separate factor because he performs specific functions different from those of other factors.
Now-a-days an entrepreneur is not considered as a separate factor but as special types of
human labourer. Whenever the ownership and the management are one and the same
entrepreneur has to perform certain specific functions.
Functions of the entrepreneur:

1. Entrepreneur initiate the business:
Entrepreneur has to initiate the business by mobilizing other factors. All the primary work
to start the business will be undertaken by him.
2. Decision making:
Major decisions like the kind of good to be produced, size of the unit, quantity of output,
price, marketing etc. have to be made by him.
3. Choosing the technology:
Choosing suitable technology, combining factors in right proportion to maximize output at
minimum cost are the other functions of organizer.
4. Innovation:
He must be dynamic to introduce new methods, techniques, products etc.
5. Pay the rewards of factors:
As entrepreneur he has to pay the rewards to other factors. He has to bear the
responsibility either for profit or loss in production
7. Explain the law of variable proportions and its importance?

Ans: Law of variable proportion:
It explains the relationship between inputs and outputs in the short period. According to
this law output can be changed by changing the some factors (variable factors) while other
factors are constant. So it is called law of variable proportions. This law was developed by
“Alfred Marshall”.
Definition:
“An increase in the amount of labour and capital applied in the cultivation of land causes in
general a less than propionate increase in the amount of output raised unless it happens to
coincide with the improvements in the arts of agriculture”. – Marshall
45
Concepts in this law:
Total product:
(1) Total Product -
It is the total amount of the output obtained by the firm ‘or’ producer by the employment
of total units of factors of production (labour). When the marginal productivities of labour
added then total productivity can be obtained
TP = f [QL ] (or) TP = ΣMP.
(2) Average product:

It is the product per unit of labour. When the total product is divided with no. of units of
labour average product can be obtained.
AP =TP /L
(3) Marginal Product:

It is an additional product obtained by the firm or producer by the employment of
additional unit of labour or one more unit of labour. The change in the total product is also
called marginal product.
∆𝑇𝑃
𝑀𝑃 =
∆𝐿
MP = TPn – TPn-1
Explanation of the law

Marshall explained this law with an example. He applied this law in the cultivation of land.
According to this law when land is kept as constant and go on increasing the labour in the first
stage increasing returns, second stage diminishing returns, and third stage negative returns
are occurred. This can be explained by the following table.
Units of labour Total product Average Product Marginal product

1 10 10 10
2 22 11 12
3 36 12 14
4 48 12 12
5 55 11 7
6 60 10 5
7 60 8.6 0
8 56 7 -4
Main points in this law:

• In the 1st stage the T.P, A.P,M.P go on increasing but at the end of the 1st stage M.P starts
to decline. The 1st stage was end when the M.P is equal to A.P.
46
• In the 2nd stage T.P goes on increasing but it increases with diminishing rate. A.P goes on
diminishing. M.P also goes on diminishing at the end of the 2nd stage the T.P reached the
maximum. When the T.P is maximum then the M.P is zero. It intersects the x-axis.
• In the 3rd stage the T.P and A.P go on diminishing but for the M.P becomes negative so
the M.P curves crossed the x-axis. The M.P curve intersects the A.P curve when the A.P is
maximum.
• The law of variable proportions is also called “law of diminishing marginal returns”.
• This law is not only applicable to agriculture sector but also applicable to industrial sector,
service sector etc.
Reasons for the diminishing returns:

• All units of variable factors are not homogenous.
• Imperfect substitutions.
• The combination becomes wrong.
Importance:
• This law is useful to firm (or) producer for the decision making regarding the output.
• According to this law the firm (or) producer operates only in second stage. He never
chooses the either first stage (or) third stage.
Assumptions:
• The units of the variable factor are homogenous.
• There is a possibility to change the some factors (Variable factors), while other factors are
constants (fixed factors).
• There is a possibility to change the combination of fixed and variable factors.
• There must be no change in the level of technology.
• It is applicable to only short period
8. Explain the law of returns to scale?
Ans: It shows the relationship between inputs and output in the long period. The change in
the quantity of the factors is called scale. Change in the output is called returns. So law of
returns to scale explains changes in the output due to changes in the inputs in the long period.
Explanation of the law:

According to this law when all inputs are increased in same proportions but the output is
not increased in the same proportion. The changes in the output are classified in to three
stages. They are
• Increasing returns to scale
• Constant returns to scale
• Diminishing returns to scale
This can be explained by the following table:
Scale of Inputs (Land Total Marginal

production + Labour) productivity Productivity
A 1+2 4 4
B 2+4 10 6
C 3+6 18 8
D 4+8 28 10
E 5+10 38 10
F 6+12 48 10
G 7+14 56 8
H 8+16 62 6
I 9+18 66 4
47
In the above table all inputs are changed in equal quantities or scale is changed. Changes in
output can be observed from total and marginal returns output changes are more clear from
the marginal returns. In the beginning when inputs are doubled marginal returns are more
than doubled. Such a change in output is called increasing returns. But in the third and fourth
combinations output has increased in the same proportion. Hence, there are constant returns
later similar change in inputs are giving diminishing returns.
Diagrammatic explanation:
In the above diagram scale or combination of inputs are presented on OX-axis and
Marginal returns on Y-axis. As inputs are increased in the first part marginal returns curve
rising i.e., they produce. In the next part the curve is stable showing constant returns. Finally,
further increase in input is resulting in decreasing returns.
Increasing returns to scale:-

If the proportionate increase in the output is more than proportionate increase in the
inputs it is said to be increasing returns to scale. It means when we double the inputs the
output will be more than double.
Cause for increasing returns:-

1. Specialization (or) Division of labour
2. Indivisible factors.
3. Dimensional economies
4. Volume discounts etc.,
Constant returns to scale:-

If the proportionate increase in the output and proportionate increase in the inputs are
same it is said to be constant returns to scale. It means when we double the inputs the output
also will be double. There are no causes for constant returns. It is just an indicator for the
ending of increasing returns and commencement of diminishing returns.
Diminishing returns to scale:-

If the proportionate increase in the output is less than proportionate increase in the
inputs, it is said to be diminishing returns. It means when we double the inputs the output will
be less then double.
Cause for diminishing returns:-

1. Management problems.
2. Limit to human factor
3. Lack of co-operation and co-ordination
4. Rise of the prices of inputs
48
Distinction between returns to a variable factor (or law of variable proportions) and
returns to scale
Returns to a variable factor Returns to scale
1. Operates in the short run or it is related 1. operates in the long-run or it is related to
short-run production – function. long-run production – function.
2. Only the quantities of a variable inputs 2. All factors- inputs are varied in the same
varied. proportion.
3. There is change in the factor-proportion. 3. There is no change in factory-ratio. For
Suppose on 1 acre land labour is employed, instance. If a firm is employing 1 unit of
then the land labour ratio is 1:1. Now if we labour and 2 units of capital, then the labour
add one more unit of labour on the 1 acre – capital ratio is 1:2. Now if the firm increase
land, then land – labour ratio would become its scale of operation and employed 2 units of
1:2 labour and 4 units of capital, the labour-
capital ratio still remains the same as 1:2.
4. No change in the scale of production. 4. there is change in the scale of production
Because here all the factor-input are not because here all the factor-inputs are varied
changed. in the same proportion.
I. List of questions
1. What is a production function?
2. What are the types of production functions?
3. What is land and explain the features of land?
4. What is Labour and explain the features of labour?
5. What is Capital and explain the functions of capital?
6. What is and Organization explain the functions of Organization?
7. Explain the law of variable proportions and its importance?
8. Explain the law of returns to scale?
II. Choose the correct answer:

1. Is the functional relationship between physical inputs (i.e. factors of production), and
physical outputs (i.e. quantity of good / service produced)
(a) Input-Output Function (b) Demand – Supply Function
(c) Production Function (d) Cost Function
2. Variable factor means those factors of production-
(a) Which can be only charged in the long run? (b) Which can be changed in the short run?
(c) Which can be never be changed (d) All of the above
3. All Factor of production become variable in –
(a) Medium – run (b) Short- run
(c) Long –run (d) none of the above
4. What is the maximum point of TP?
(a) When AP become zero (b) When MP become zero
(c) At the intersecting point of AP& MP (d) None of these
5. At the point of Infixion, TP will generally-
(a) Show increases trend (b) Show decreasing trend
(c) Equal to Zero (d) be negative
6. If the Marginal product of labour is below the Average product of Labour, it must be true that
(a) The Marginal product of Labour is negative (b) The Marginal Product of Labour is Zero
(c) The Marginal Product of Labour is falling (d) The Average product of Labour is negative
7. Why does the Law of Increasing Returns operate?
(a) Full use of Fixed Indivisible Factors. (b) Efficiency of Variable Factors.
(c) Need to reach the right combination (d) All of the above
8. A Rational Producer will operate in –
(a) Stage I (b) Stage II (c) Stage III (d) All of the above
9. When the mp=AP, then the AP is ………..
(a) Maximum (b) Minimum (c) Less (d) More
49
10. Identify the correct statement.
(a) Average product is at its maximum when Marginal Product is equal to Average Product.
(b) Law of Increasing Returns to Scale relates to the effect of changes in factor proportions.
(c) Economies of Scale arise only because of invisibilities of factor proportions.
(d) Internal Economies of scale can accrue only to the exporting sector.
11. Let a firm employs 10 labourers to produce 150 units of output. If 11 labourers are
employed to produce 166 units of output, then the marginal product is
(a) 11 (b) 16 (c) 150 (d) 166
12. A rational producer produces in that region where
(a) Marginal physical product of the fixed input becomes negative.
(b) Marginal physical product of the variable input becomes negative.
(c) Marginal physical product of the fixed input becomes increasing.
(d) Marginal physical product of the variable input becomes Decreasing
13. If a firm doubles all inputs, and output doubles as well, the firm is subject to
(a) Constant returns of scale (b) Increasing returns
(c) Decreasing returns to scale (d) Economies of scales
14. Factors of production may be of _____________ only
(a) 4 (b) 3 (c) 2 (d) 5
15. The Law of Variable Proportions relates to ______________ only
(a) Long-run (b) Short-run (c) Very long-run (d) Very short-run
16. ____________ is the centre of all marketing policies.
(a) Price (b) Product (c) Profit (d) Publicity
17. Production creates _________________ utility
(a) Place (b) Time (c) Form (d) Possession
18. A production Function refers to __________
(a) Scale of Production (b) Relationship between resources
(c) Relationship between inputs and output (d) Relationship between costs and output
19. ____________ is a gift of nature
(a) Land (b) Labour (c) Capital (d) Organisation
20. There are ___________ stages of the Law of Variable Proportions.
(a) 2 (b) 3 (c) 4 (d) 5
21. Which factor of production is considered as a produced means of production?
(a) Land (b) Labour (c) Capital (d) Organisation
22. Law of variable proportions was developed by ____________
(a) Alfred Marshall (b) Adam Smith (c) Robbins (d) Jacob
23. Returns to a variable factor operates in ________
(a) Short run (b) Long Run (c) Either “a” or “b” (d) Neither “a” nor “b”
24. All factors of production become variable in ________
(a) Medium run (b) Short run (c) Long run (d) None of the above
25. Identify the correct statement
(a) AP is at its maximum when MP=AP
(b) Laws of increasing returns to scale relates to the effect of changes in factor proportion
(c) Economies of scale arise only because indivisibilities of factor proportions
(d) All the statements are correct
26. Law of variable proportions applies
(a) When all inputs are variable (b) When all inputs are fixed
(c) Some inputs are fixed and some are variable (d) Al the three
27. Total output is maximum when
(a) MP = 0 (b) MP is increasing (c) MP is decreasing (d) MP is constant
28. The most efficient scale of production of a firm is where:
(a) LAC is minimum (b) SAC is minimum (c) LMC minimum (d) SMC is minimum
29. Which of the following is not an input?
(a) Labour (b) Entrepreneurship (c) Natural Resources (d) Production
30. When marginal is negative, it must be true that:
(a) The average is negative (b) The average is decreasing
50
(c) The total is negative (d) The total is decreasing
31. Profits are:
(a) Residual payment (b) Pre-determined
(c) Fixed contract (d) Always higher than wages
32. In Economics, production means:
(a) Farming (b) Creating Utility (c) Making (d) Manufacturing
33. Why is the law of diminishing marginal returns true?
(a) Specialization and division (b) Spreading the average fixed cost
(c) Limited Capital (d) all factors being variable in the long-run
34. Under law of diminishing return, MP is zero when the TP is at the –
(a) Minimum (b) Maximum (c) Nil (d) Equal
35. When total product is maximum, marginal product is –
(a) Falling (b) Zero (c) Rising (d) Negative
36. MP cuts AP when –
(a) MP is minimum (b)MP is maximum (c) AP is maximum (d) AP is minimum
37. The average product of labour is maximized when marginal product of labour –
(a) Equals the average product of labour (b) Equls zero
(c) Is maximized (d) None of the above
IV. State the sentence true or false

1. Production function explains the relationship between inputs and output ( )
2. The factor which are available in the short period are called fixed factors ( )
3. When the marginal product is divided with number of unity labour then AP can be
obtained ( )
4. Imperfect substation is one of the reasons for diminishing marginal returns ( )
5. When the TP is maximum, then the AP is zero ( )
6. Land is subject to diminishing return ( )
7. All the laborers have equal efficiency ( )
8. Capital can generate more employment ( )
9. Decision making is the function of capital ( )
10. Rise in the prices of Input is one of the cause for diminishing return to scale ( )
11. The Law of Variable Proportions is relevant to Short Run.
12. When the output is zero, variable cost is also zero
13. Production function expresses the relationship between the physical inputs and
physical output of a firm for a given state of technology
V. Matching:
1. Fixed factors () A. increasing returns
2. Land () B. short period
3. Σ mp () C. fixed factor
4. Indivisible factors () D. total product
5. Immobile factor () E. Perishable
6. Labour () F. Raw material
7. Innovation () G. marginal product
8. Capital () H. Long period
9. ∆ TP () I. Land
10. variable factors () J. Entrepreneur
VI. Give the answer in one (or) two sentences

1. Marginal product
Ans: It is an additional productivity obtained by the firm or producer by the employment of
additional unit of labor or one more unit of labour. The change in the total productivity is also
called marginal productivity.
∆𝑇𝑃
𝑀𝑃 = ∆𝐿
51
MP = TPn – TPn-1.
2. Increasing returns to scale
Ans: If the proportionate increase in the output is more than proportionate increase in the
inputs it is said to be increasing returns to scale. It means when we double the inputs the
output will be more than double.
3. Diminishing returns to scale

Ans: If the proportionate increase in the output is less than proportionate increase in the
inputs it is said to be diminishing returns. It means when we double the inputs the output will
be less than double.
4. Variable factor:
Ans: The factors which are available to change the output in the short period, they can be
changed so they are called variable factors.
Example: Capital, labour, raw materials etc.,
5. Total product:
Ans: It refers to the total output of the firm per period of time
It is the total amount of the output obtained by the firm ‘or’ producer by the employment
of total units of factors of production (labour). When the marginal productivities of labour
added then total productivity can be obtained.
TP = f [QL ] (or) TP = Σmp
6. Fixed factors:
Ans: The factors which are not available in the short period they can be kept as constant. So
they are called fixed factors.
Example: land, building, machines etc.
7. Land:
Ans: Land in common usage is soil or surface of the earth. As a factor of production it refers to
all natural resources like forests, water, climate, minerals etc. It mainly supplies food to
people, provides space for work and supplies raw material to industry.
8. Labour
Ans: In the ordinary usage, labour stands for only physical labour. In economics, labour means
physical as well as mental services engaged in production to earn income. Classical economists
and Karl Marx have considered labour as the sole factor of production.
9. Capital:
Ans: In the ordinary sense capital means money for an individual or a firm. Money is a form of
capital when it is used to purchase machinery, tools, raw materials etc. Ultimately it is these
man made goods i.e. Machinery, tools etc. that help in the production of goods. These are
vital in raising productivity in different sectors.
10. Entrepreneur:
Ans:The person who organizes the production is called an entrepreneur. He is considered as a
separate factor because he performs specific functions different from those of other factors.
Now-a-days an entrepreneur is not considered as a separate factor but as special types of
human labourer.
Answers
1. B 2. B 3. C 4. B 5. A 6. C 7. D 8. B 9. A 10. A
III. Fill in the blanks:

1. a free gift 2. Fertility 3. Weak
52
4. inseparable 5. Tools 6. Capital
7. Entrepreneur (or) Organizer 8. Entrepreneur
9. Law of variable proportions 10. Perishable
IV. State the sentence true of false

1. T 2. F 3. F 4. T 5. F 6.T 7. F 8. T 9. F 10. T
V. Matching
1. B 2. C 3. D 4. A 5.I 6.E 7.J 8.F 9.G 10.H
53
STUDY NOTE 4
THEORY OF COSTS
1. What is meant by cost of production? And explain the types of costs?
Ans: It is the expenditure incurred by the producer (or) firm to produce the goods and
services. But it is the remunerations (or) income of factors of production point of view.
C = f(Q).
Types of cost:
1. Money:
If the remunerations of the factors of production are paid in the form of money it is called
money cost. For example: rent paid to the land, wages to the labourers etc.
2. Real cost:
The concept of real cost was introduced by Alfred Marshall. Exertions of all kinds of labour
that are already indirectly involved in production process. All these efforts and sacrifices
together will be called as real cost of production. For example exertions of all kinds of labour,
waiting and sacrifices required for saving the capital.
3. Economic costs:
Total expenses incurred by a firm (or) producer in producing a commodity are called
economic costs. These economic costs includes
(a) Explicit costs
(b) Implicit costs
(c) Normal profit.
(a) Explicit costs:

Actual payments made by a firm for purchasing or hiring resources are called explicit
costs. These costs are actual money expenses directly incurred for purchasing the resources
for example rent to the land, wages to the labourer, expenditure on raw material interest on
borrowed money etc.,
(b) Implicit costs:

These costs are imputed costs of the factors of productions owned by the producer
himself which are generally left out in the calculation of expenses of the firm. For example
rent for the use own land, interest on his own capital etc.
• Explicit costs are recorded in the account books but implicit costs are not recorded.
• Explicit costs are also called “Accounting costs”.
(c) Normal profits:

The minimum amount which is required to keep an entrepreneur in the production
process is known as normal profit.
• Economic cost = Explicit cost + Implicit cost + normal profits.
(4) Opportunity cost:

The opportunity cost of anything is next best alternative cost which is forgone. Individual
point of view (or) nation point of view the resources are scarce. At that time to get the one
commodity we have to forego the another commodity. This is called opportunity costs
2. State the importance of opportunity cost?

Ans: Opportunity cost:
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The opportunity cost of anything is next best alternative cost which is forgone. Individual
commodity we have to forego the another commodity. This is called opportunity costs.
Suppose a piece of land can be used for growing wheat or rice. If the land is used for
growing rice, it is not available for growing wheat. Therefore the opportunity cost for rice is
the wheat crop foregone.
This is illustrated with the help of the following diagram.
Suppose the farmer, using a piece of land can b produce either 50 quintals (ON) of rice or
40 quintals (OM) of wheat. If the farmer produced 50 quintals of rice (ON), he cannot produce
wheat. Therefore the opportunity cost of 50 quintals (ON) of rice is 40 quintals (OM) of wheat.
The farmer can also produce any combination of the two crops on the production possibility
curve MN. Let us assume that the farmer is operating at point A on the production possibility
curve where he produces OD amount of rice and OC amount of wheat. Now, he decides to
operate at point B on the production possibility curve. Here he has to reduce the production
of wheat from OC to OE in order to increase the production of rice form OD to OF. It means
the opportunity cost of DF amount of rice is the CE amount of wheat.
Applications of Opportunity cost

The concept of opportunity cost has been widely used by modern economists in various
fields.
1. Determination of factor prices:
The factors of production need to be paid a price that is at least equal to what they command
for alternative uses. If the factor price is less than factor’s opportunity cost, the factor will quit
and get employed in the better-paying alternative.
2. Determination of economic rent:

The concept of opportunity cost is widely used by modern economists in the
determination of economic rent. According to them economic rent is equal to the factor’s
actual earning minus its opportunity cost (or transfer earnings).
3. Decisions regarding consumption pattern:

The concept of opportunity cost suggests that with given money income, if a consumer
chooses to have more of one thing, he has to have less of the other. Hence with the help of
opportunity cost he decides the consumption pattern, that is, which goods should be
consumed and in what quantities.
4. Decisions regarding production plan:

With given resources and given technology if a producer decides to produce greater amount
of one commodity, he has to sacrifice some amount of another commodity.
5. Decisions regarding national priorities:

If a country decides that more resources must be diverted to arms production then less
will be available to produce civilian goods. In this situation a choice will have to be made
55
between arms production and civilian goods. The concept of opportunity cost helps in making
such choices.
3. Distinguish between fixed costs and variable costs?

Ans: Cost Function:
The cost function explains the functional relationship between cost of production and
physical quantity of output.
C = f(Q)
Short run costs:

In the short period cost of production can be divided into two types. They are
1. Fixed costs
2. Variable costs
1. Fixed costs:
The costs which don’t change with change of the output are called fixed costs. It means
output may be increase (or) decrease but no change in these costs. When the output is
stopped the producer must incurred this cost. Even the output is zero the fixed cost is
positive. The fixed cost curve (TFC) will be parallel to ox-axis.
Example: expenditure on the land, building, salaries of permanent employees, interest
payment, insurance premium etc.
2. Variable costs:
Costs which are changed with change of the output are called variable costs. It means
when the output is increased these costs are also increased, when the output is decreased
these costs are also decreased. When the output is zero these costs are also zero. The TVC
curve will be sloped upwards from “left to right” And it is started from the origin.
Example: Expenditure on raw material, power, fuel, wage of daily laborers etc.
Fixed costs Variable costs

1. Fixed costs do not vary with quantity of 1. Variable costs vary with the quantity of
output. output.
2. They are related with the fixed factors. 2. They are related with the variable factors.
3. They do not become zero. They remain 3. They can become zero when production
same even when production is topped. is stopped.
4. A firm can continue production, not 4. Production should at least recover the
recovered even fixed costs. variable cost.
3. Total costs:
When the fixed cost are added with variable costs then the total cost can be obtained,
when the output increases total costs are also increased and when the output decreases total
costs are also decrease. The total cost curve will slope upwards from the left to right as there
direct proportional relationship between output and total cost. It is positive when the output
is zero.
4. Explain about short run costs with suitable diagrams?

Ans: But the TC curve is started above the origin and where TFC curve is started.
TC = TFC +TVC
Output TFC TVC TC
0 20 0 20
1 20 18 38
2 2- 30 50
3 20 40 60
4 20 52 72
56
5 20 65 85
6 20 82 102
7 20 106 126
8 20 140 160
Diagram:-
Other cost curves in short period:

We can derive the other costs (concepts) from the above table this can be explained by
the following table.
Output TFC TVC TC AFC AVC AC ∆TC/MC

0 20 0 20 - - - -
1 20 18 38 20 18 38 18
2 2- 30 50 10 15 25 12
3 20 40 60 6.66 13.33 20 10
4 20 52 72 5 13 18 12
5 20 65 85 4 13 17 13
6 20 82 102 3.33 13.66 17 17
7 20 106 126 2.85 15.14 18 24
8 20 140 160 2.5 17.5 20 34
1. Average fixed cost:

It is the average total fixed cost per unit of output when TFC is divided with no. of units of
output AFC can be obtained
𝑇𝐹𝐶
𝐴𝐹𝐶 =
𝑄
 The AFC curve slopes downwards from left to right and it is Rectangular hyperbola.
2. Average variable cost:
57
It is the average total variable cost per unit of output when the TVC are divided with no.of
units of output AVC can be obtained
𝑇𝑉𝐶
𝐴𝑉𝐶 =
𝑄
 The AVC curve will be in ‘U’ shape
3. Average cost:
It is the average total cost per unit of the output. When the total cost is divided with no.of
units of outputs AC can be obtained.
𝑇𝐶
𝐴𝐶 = 𝑄 (or) AFC + AVC
 The average total cost curve is in ‘U’ shape
4. Marginal cost:-
It is the additional cost to produce the additional unit of a thing (or) one more unit of a
thing. The change in the total cost is also called marginal cost.
∆𝑇𝐶
𝑀𝐶 = ∆𝑄 (or) TCn – TCn-1 units
Marginal cost curve is also in ‘u’ shape
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Difference between Marginal Cost and Average Cost:
Average cost:
It is the average total cost per unit of the output. When the total cost is divided with no.of
units of outputs AC can be obtained.
𝑇𝐶
𝐴𝐶 = 𝑄
(or) AFC + AVC
Marginal cost:-
It is the additional cost to produce the additional unit of a thing (or) one more unit of a
thing. The change in the total cost is also called marginal cost.
∆𝑇𝐶
𝑀𝐶 = (or) TCn – TCn-1 units
∆𝑄
Marginal cost curve is also in ‘u’ shape
The difference between MC and AC can be explained by the following diagram
In the above diagram in the 1st stage both MC and AC go on diminishing. The MC is less
than AC, so in the 1st stage MC curve is below and AC curve is above. In the second stage when
MC and Ac go on increasing. The MC is more than the Ac. So in this stage the mc curve is
above and AC curve is below. Changes in the MC are more than changes in Ac. Mc curve cuts
the AC curve when the AC is minimum (abnormal profits).
5. Explain about long run costs with suitable diagrams?

Ans: Long run cost curves:
In a short period a firm has a fixed scale of plant the short run average cost curve
corresponding to a particular scale of plant. So in short period the firm can operate on a
particular scale of plant. But in the long run a firm can choose among possible sizes of plant
(or) it can move from one scale of plant to another scale of plant. This can be shown by the
following diagram.
59
In the above diagram there are various short run average cost curves which correspond
various sizes of plant. The LAC curve will be tangent to each of the short run AC curve. It
shows the least possible AC producing a quantity of the output when scale of plant is varied.
6. State the economics of large scale production?

Ans: Economies of large scale production:
When the factors of production [inputs] are employed in larger quantities then the output
is in larger quantities. It is called large scale production. When the output is carried on larger
quantities there are some advantages. These advantages are called economies of the large
scale production. These economies are divided in to 2 types. They are
1. Internal economies 2. External economies
Internal Economies:
When a firm expands its size of business (or) increases its output, it gets some advantages.
They are called internal economies. These internal economies are related to a single firm and
not related to all other firms in the industry.
Types of the internal economies:
1. Labour economies:
Division of labour and specialization are possible more in large-scale operations. Different
types of workers can specialize and do the job for which they are more suited. As a result of
this quality and speed of work both improve.
2. Technical economies:
A large firm will be able to install large capacity of machines in place of small sized
machines. It also adopts latest technologies. These will give mechanical advantage over small
firms and costs will be minimum.
3. Managerial economies:
Highly talented managers of specialized skills will be employed by large firms. It helps to
makes better decisions in the production.
4. Marketing economies:
Large scale purchase of raw materials and sale of finished goods gives the advantage of
transport concessions to the firm. Advertisement costs will be less due to large output sales.
5. Financial economies:
Large firms will be able to borrow credit easily. These firms will be able to offer securities
and their goodwill in the market enables them to borrow at reasonable rate of interest. They
also raise capital by attracting investors.
6. Research and Development:
Improvements in technology efficient use of resources improvement in quality of products
depend on research. Only large firms can afford to bear the expenditure on research.
7. Economies Related to Transport and Storage costs:
Large firms are able to enjoy freight concession from railways and road transport. Because
a large firm uses it s own transport means and large vehicles, the per unit transport costs
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would fall. Similar, a large firm can also have its own storage godowns and can save storage
costs.
8. Risk bearing economies:
Generally large firms diversify their production into different goods and services.
Therefore, even if there is a loss in one item of good it can be covered by profit in other
goods.
Internal diseconomies:
Internal diseconomies are those disadvantages which are internal to the firm and accrue
to the firm when over it expands its scale of production. The main internal diseconomies of
scale are as follows:-
1. Management diseconomies
These diseconomies occur primarily because of increasing managerial difficulties with too
large as scale of operations. It becomes difficult for the top management to exercise control
and to bring about proper coordination.
2. Technical diseconomies
If a firm frequently changes in it technologies and used new technologies and new
machines, it may increase its costs. After a certain limit, the large size or volume of the plant
and machinery may also prove disadvantageous.
3. Risk bearing diseconomies
The business cannot be expanded indefinitely because of the principle of increasing risk.
The risk of the firm increases because of reduction in demand change in fashion and
introduction of new substitutes in the market.
4. Marketing diseconomies
A large firm is forced to spend more on bringing and storing of raw materials and selling of
finished goods in the distant markets.
5. Financial diseconomies
A large firm has to borrow a large amount of money even at higher rate of interest. It
imposes a burden on the financial position of the firm.
Impact of internal economics and internal diseconomies on LAC curve:
When a firm accrues internal economies with the expansion of its scale of output, the LAC
curve would fall. And when after a certain point, a firm receives internal diseconomies with
the expansion of its scale of output, the LAC curve would rise.
Thus, internal economies causes the LAC to fall and internal diseconomies cause the LAC
to rise. Hence the internal economies and diseconomies are responsible for the U-shaped of
the LAC curve. It is shown in the diagram.
External Economics:
Firm is a unit, the group of firms is called industry. When industry is expended they are
some advantages. These advantages are enjoyed by all the firms in the industry so they are
called external economies. These economics are opened for all the firms it means they are not
related to a single firm.
Types of external economics:
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1. Economies of localization (or) concentration
Location of several firms at one place makes available certain facilities. Local authorities
may develop roads, communication, power, irrigation etc. Other facilities like banking,
insurance, skilled labour will come up in the area. These arrangements benefit all the firms
located in that place.
2. Economies of disintegration (or) specialization
Production of goods can be split into different parts and each firm may take up one part
of producing the goods. This will result in specialization and improve performance of each firm
in the production. This division of labour helps to produce more output and reduces costs of
production.
3. Economies of related to information services
All the firms in the area are dealing with the same goods. Information can be shared
among the firms about raw material, skilled labour, marketing etc. Expenditure on these items
can be reduced and there will be mutual advantage to all the firms.
4. Economies of producers’ organization
Collective research by all the firms on new products, technologies will help reduce
expenditure. The fruits of research can be enjoyed by all the firms.
External diseconomies:
Diseconomies which accrue to the firms as a result of the expansion in the output of the
whole industry are termed external diseconomies. The main external diseconomies are as
follows:
1. Increase in the input prices

When the industry expands, the demand for factor-inputs increases. As a result the input
prices (such as wages, prices of raw materials and machinery equipments, interest rates,
transport and communication rates etc.) shoot up. This causes the cost of production to rise.
2. Pressure on infrastructure facilities

Concentration of firms in a particular region creates undue pressure on the infrastructure
facilities – transportation water, sanitation, power and electricity etc. As a result, bottlenecks
and delays in production process become frequent which tend to raise per unit costs.
3. Economics due to exhaustible natural resources
Diseconomies may also arise due to exhaustible natural resources. Doubling the fishing
fleet may not lead to a doubling of the catch of fish; or doubling the plant in mining or on an
oil-extraction field may not lead to a doubling of output.
4. Diseconomies of disintegration
When the production of a commodity is disintegrated among various processes and sub-
process, it may prove disadvantageous after a certain limit. The problem and fault in any one
unit may create limit. The problem and fault in any one unit may create problem for whole of
the industry, Coordination among different concerns also poses a problem.
Impact of external economics and external diseconomies on LAC curve:

(i) As a result of external economies, the LAC curve of the firms shifts downwards. It is
shown in the diagram below that because of external economies. LAC curve shifts downwards
from LAC1 to LAC2.
(ii) As a result of external diseconomies the LAC curve of the firms shifts upwards. It is
shown in the diagram below that because of external diseconomies. LAC curve shifts upwards
from LAC1 to LAC3.
62
Concepts of Revenue
It is the income obtained by the firm or producer by the sale of goods and services in the
market. There are three concepts in revenue. They are
1. Total revenue:
It is the total amount of income obtained by the firm ‘or’ producer by the selling of total
goods and services in the market. The sum of all marginal revenue is also called total revenue
TR = PXQ
(or)
TR = Σ MR
2. Average Revenue:
It is the revenue per unit of output to be sold in the market. When the total revenue
divided with no. of units of output AR can be obtained
AR= TR / Q.
3. Marginal Revenue:
It is the additional revenue obtained by the firm (or) producer by the selling of additional
unit of a thing (or) one more unit of a thing. The change in the total revenue is also called
marginal revenue
∆𝑇𝑅
𝑀𝑅 =
∆𝑄
(or)
MR =TRn – TR(n-1) units.
7. Draw the AR and MR curves under different markets?
Ans: Revenue curves under different markets:
The revenue curves are different from one market to another market. They are in one
type in perfect competition market and another type in imperfect competition market.
AR and MR curves under perfect competition market

In perfect competition market the price is constant as the goods are homogeneous. So
how the AR and MR are changed when the output is increased can we shown in following
table.
Output Price TR AR MR
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
From the above table AR and MR curves can be drawn in the following diagram.
Diagram:
63
In the above diagram AR=MR curve is parallel to ox-axis. Because the price is constant in
this market.
MR and AR curves under Imperfect market:

In imperfect market the price is changed. When the seller want to increase the sales he
must reduce the price. When the price is decreased, then the average revenue and marginal
revenue are also decreased. This can be shown by the following schedule.
Output Price TR AR MR
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 5
5 6 30 6 2
From the above table AR and MR curves can be derived. This can be shown by the
following diagram.
Diagram:
 In imperfect market both MR and AR curves slope downwards, from left to right. Here the
MR curve is below the AR curve.
 The price is always equal to “Average revenue” (P=AR) in all markets.
I. List of questions
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1. What is meant by cost of production? And explain the types of costs?
2. State the importance of opportunity cost?
3. Distinguish between fixed costs and variable costs?
4. Explain about short run costs with suitable diagrams?
5. Explain about long run costs with suitable diagrams?
6. State the economics of large scale production?
7. Draw the AR and MR curves under different markets?
II. Choose the correct Answer:
1. Explicit cost refers to _

(a) all anticipated future costs (b) opportunity cost of next best alternative forgone
(c) actual expenses to purchase or hire inputs (d) all the three
2. Which of these is an example of explicit cost
(a) Cost of raw material (b) notional rent of the office building
(c) interest on capital employed by the entrepreneur (d) all the three
3. Which of these is an example of implicit cost
(a) labour wages (b) cartage on goods purchased
(c) rent of owned factory building (d) Lease charges of plant
4. Which of these costs will increase or decrease with production.
(a) variable cost of production (b) Fixed cost of production
(c) Both (d) Average cost of production
5. Labour supply curve is __
(a) upward sloping (b) downward sloping (c) backward sloping (d) a straight line
6. Which of these cost curves shape rectangular hyperbola _
(a) AVC (b) MC (c) TFC (d) AFC
7. Which of these costs declines continuously _
(a) AVC (b) MC (c) TFC (d) AFC
8. The sum total of explicit costs and implicit cost is termed as _
(a) Accounting cost (b) Historical cost (c) Economic cost (d) real cost
9. TVC rises with increasing rate when law of ___ is in operation
(a) diminishing returns (b) increasing returns
(c) Constant returns (d) any of the above three
10. The average total cost and the average variable cost corresponding to production of 30
unit is Rs. 30 and Rs. 27 respectively, the total fixed cost of the firm will be __
(a) Rs. 60 (b) Rs. 80 (c) Rs. 90 (d) Rs. 100
11. As output increases, AFC of a firm
(a) Increases (b) Remains constant
(c) Continuously decline (d) Initially increases, afterwards declines
12. Opportunity cost is measured in terms of the
(a) Optional cost that has been avoided (b) Negative cost that has been sacrificed
(c) Accounting cost that has been paid (d) Next best alternative that has been foregone
13. Due to the operation of Laws of return to scale LAC curve is
(a) Rectangular hyperbola (b) U-shaped
(c) Parallel to the horizontal axis (d) Parallel to the vertical axis
14. ____________ Cost is also known as Alternative Cost
(a) Opportunity (b) Actual (c) Real (d) Money
15. The additional cost incurred to produce an additional unit of output is _____________
(a) Marginal Cost (b) Variable Cost (c) Fixed Cost (d) Opportunity Cost
16. The average __________ and output have inverse functional relationship
(a) Fixed cost (b) Variable cost (c) Marginal cost (d) Total cost
17. Economies of scales are divided into _____________ types
(a) 2 (b) 3 (c) 4 (d) 5
18. Marginal revenue is
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(a) Total revenue minus total cost (b) Total revenue divided by quantity of
output (c) The change in total revenue divided by the change in output
(d) The change in total revenue divided by the change in the quantity of an input used
19. Change in cost of production of the concerned goods causes
(a) The demand curve to shift (b) The supply curve to shift
(c) Increase in quantity demanded (d) Decrease in quantity supplied
20. Implicit cost refers to ……………
(a) Value of inputs owned by the firm and used in its own manufacturing process
(b) Value of input or services purchased from outside and used in its own manufacturing process
(c) Value of inputs owned by the firm and sold to others
(d) Value of inputs or services for which no payments were made to outside
21. The capital that is consumed by an economy or a firm in the production process is known by:
(a) Capital loss (b) Production cost (c) Dead-weight loss (d) Depreciation
22. Who propounded the opportunity cost theory of international trade?
(a) Ricardo (b) Marshall (c) Heckscher & Ohlin (d) Haberier
23. The following is the cost of clothing manufacturer. State which among them will you
consider as fixed cost?
(a) Cost of cloth (b) Piece wages paid to worker
(c) Depreciation on machines owing to time (d) Cost of electricity for running machines
24. In the short run, when the output of a firm increases, its average fixed cost:
(a) Remains constant (b) Decreases (c) Increases (d) First decreases and then rises
25. LAC curve is also known as:
(a) Envelop curve (b) Planning curve
(c) Both of the above (d) None of the above
26. Suppose the total cost of production of commodity x is Rs.1,25,000. Out of this implicit
cost is Rs.35,000 & normal profit is Rs.25,000. What will be the explicit cost of commodity x ?
(a) 90,000 (b) 65,000 (c) 60,0000 (d) 1,00,000
IV. State the sentence true or false

1. The main cause for the ‘U’ shape of LAC curve is internal economics and internal
diseconomies ( )
2. As a reason of external economics the LAC curve shifts upwards ( )
3. In perfect market AR=MR curve is parallel to ox-axis ( )
4. In imperfect market MR curve is a below the AR curve ( )
5. In perfect market and imperfect market the price is equal to average revenue. ( )
6. The cost of the owned resources used by the firm is called implicit cost ( )
7. In the long run distinction is made between variable and fixed cost ( )
8. Average fixed cost is always downward sloping but never touch x axis ( )
9. When average cost falls as a result of an increase in output, marginal cost is less than
average cost ( )
10. Short run cost curves are also called panning curves. ( )
11. When the output is zero, the fixed cost is also zero ( )
V. Matching
1. Implicit cost () A. LAC curve
2. Normal profit () B. Average cost
3. National priorities () C. real cost
4. Planned curve () D. Opportunity cost
5. AFC+AVC () E. rent to own land
6. Waiting of sacrifices () F. Economic cost
7. Labour Economies () G. External economic
8. Marginal Revenue () h. long period
9.Variable cost () (i) Internal economies
10. Economic of producing organization () (j) ∆ TR
66
V. Give the answer in one (or) two sentences
1. Average Revenue:
Ans: It is the revenue per unit of output to be sold in the market. When the total revenue
divided with no. of units of output AR can be obtained
𝑇𝑅
AR =
𝑄
2. Fixed costs:
Ans: The costs which don’t change with change of the output are called fixed costs. It means
output may be increase (or) decrease but no change in these costs. When the output is
stopped the producer must incurred this cost. Even the output is zero the fixed cost is
positive. The fixed cost curve (TFC) will be parallel to ox-axis.
3. Economic costs:
Ans: Total expenses incurred by a firm (or) producer in producing a commodity are called
economic costs. These economic costs includes
(a) Explicit costs (b) Implicit costs (c) Normal profit.
4. Real costs
Ans: The concept of real cost was introduced by Alfred Marshall. Exertions of all kinds of
labour that are already indirectly involved in production process. All these efforts and
sacrifices together will be called as real cost of production. For example exertions of all kinds
of labour, waiting and sacrifices required for saving the capital.
5. Explicit cost
Ans: Actual payments made by a firm for purchasing or hiring resources are called explicit
costs. These costs are actual money expenses directly incurred for purchasing the resources
for example rent to the land, wages to the labourer, expenditure on raw material interest on
borrowed money etc.,
6. Opportunity cost
Ans: The opportunity cost of anything is next best alternative cost which is forgone. Individual
commodity we have to forgo the another commodity. This is called opportunity costs.
7. Internal economics
Ans: When a firm expands its size of business (or) increases its output, it gets some
advantages. They are called internal economics. These internal economics are related to a
single firm and not related to all other firms in the industry.
8. External Economics
Ans: Firm is a unit, the group of firms is called industry. When industry is expended they are
some advantages. These advantages are enjoyed by all the firms in the industry so they are
called external economies. These economics are opened for all the firms it means they are not
related to a single firm.
9. Marginal revenue
Ans: It is the additional revenue obtained by the firm (or) producer by the selling of additional
unit of a thing (or) one more unit of a thing. The change in the total revenue is also called
marginal revenue
∆𝑇𝑅
𝑀𝑅 = ∆𝑄
67
(or)
MR = TRn– TR(n-1) units.
10. Technical economies:

Ans: A large firm will be able to install large capacity of machines in place of small sized
machines. It also adopts latest technologies. These will give mechanical advantage over small
firms and costs will be minimum.
Answers
1.C 2. A 3. C 4. A 5. C 6. D 7.D 8. C 9.A 10.C

1. AFC 2. Implicit cost 3. Explicit 4. Fixed 5. Normal profit6. Marginal
7. ‘U’ shaped 8. Fixed 9. Minimum 10. Marginal cost
VI. True or False:

1. T 2. F 3. T 4. T 5. T 6.T 7. F 8. T 9.T 10.F
V. Matching:
1. E 2. F 3. D 4. A 5. B 6. C 7. I 8.J 9.H 10-G
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STUDY NOTE 5
MARKETS
1. What is market? And explain the various forms of market?

Ans: Meaning Market:
The term market refers to a place where the goods are bought and sold.
According to Benham “Any area over the buyers and sellers have close contact either directly
or through agents, the price obtainable in one part effect the price paid in other parts is called
market”.
Classification of Markets:
On the bases of various concepts we can classify market into various types. These can be
shown by the following chart.
Market
Competition Area Time
Perfect Imperfect Local National International

Competition Competition Market Market Market
Monopoly Monopolistic Oligopoly Duopoly

Competition
Very Short Short Long

Period Period Period
Market Market Market
1. Competition Based Market:

Markets are of two types based on competitions.
1. Perfect competition: It is a market with a very large number of buyers and sellers. Market
conditions are favourable to promote competition. Such a market is called perfect competition.
2. Imperfect competition: Market with a limited number of buyers and sellers come under
imperfect competition based on the number of producers. These markets are broadly monopoly,
monopolistic competition and oligopoly.
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I. Area based markets:
A market based on area are broadly classified into local, national, international market. These
market tell us the size or extent of the market for a good.
1. Local Market: Sometimes a particular commodity is exchanged in the locality where it is
produced. Then the commodity is said to have a local market. Vegetables, flowers, fruits may
be produced and marketed in the same area.
2. National Market: A commodity will have national market if it is demanded and supplied by
people. In different parts of the country. Commodities like wheat, sugar, cotton have national
market.
3. International market: If a commodity is sold and purchased in different countries it is said
to have international market for example gold, silver, wheat, cotton have international market.
This classification is not always true-with the development of new technologies. Some goods
that are used to have local market are now sold in other countries. Facilities like cold storages
improved, transportation, changing tastes of consumers have become possible now resulting in
several goods having international market.
II. Time – Based Markets:

Finally, there are markets based on adjustments in supply of commodity. Changes in the supply
of a commodity depends on time periods. They are divided into three periods i.e. market period,
short period and long period.
1. Market period: This is also called a very short period. A producer cannot make any
changes in the supply of a good during this period. Inputs cannot be changed in the very short
period. Supply remains constant in this period. A farmer on a particular day supplies whatever
vegetables he gets from the field.
2. Short period: It is a period in which supply can be changed to some extent. This is possible
by changing certain inputs. Example: In a period of two to three weeks a farmer may use more
fertilizer, water to increase his supply.
3. Long period: A producer makes changes in all inputs depending upon the demand in the
long period. It is possible to make adjustments in supply. In this period crop area implements
and others can be changed to increases output in the next season.
2. Define perfect competition market? And state how the price is determined under this
market?
Ans: Where there are a large number of buyers and sellers are engaged in the exchange of
homogeneous goods without any restrictions is called perfect competition market.
Definition:
“The more nearly perfect market is the stronger tendency for the same price to be paid for
the same thing in all parts of the market” – Alfred Marshall.
Features of Perfect Market:

The perfect competition market has the following features.
1. Large number of sellers and buyers:
There will be a large number of sellers and buyers for a good in this market. It means the
output of a buyer or a seller is a small part of the total output. A single producer or seller
cannot change the price by his actions. None of them is large enough to influence the price.
Therefore a seller takes the price decided by the market. The producer is a price taker.
2. Homogeneous Commodities:
Products in this market are similar in every aspect. A consumer gets the same good whenever
he purchases. As a result there will be one price all over the market.
3. Free entry and exit:
Any firm can enter into the production as per its desire. Finally it can leave the production
at any time. This helps new firms to enter into business when conditions are favourable. As
long as a firm earns super normal profits, it usually stays in competition. But when the firm
ends up with losses, it would leave the market.
4. Mobility of factors of production:
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Factors of production will move from one production to another easily. This is also useful
for free entry and exit of firms factors (land, labour, capital) move to the production activities
where they get higher incomes.
5. Absence of transport cost:

Under perfect market transport costs should not be added in the price. If transport costs
are added the goods are available at the fewer prices at the near markets and they are
available at the higher prices at distant markets. Existing of two prices for the same thing in
different parts is against for perfect market. So transport cost should not be added.
6. Perfect knowledge of market:
Buyers and sellers in this market will have a clear knowledge about market conditions. So
that there will be one price throughout the market. Because of perfect knowledge, sales and
purchases of commodities take place as one price.
Price determination:
In a perfect situation price is decided by the market. Market brings about a balance
between the commodities that come for sale and those demanded by consumers. It means
the forces of supply and demand determine the price of the good. Equilibrium price is
established at the point where the supply and demand are equal. A table helps us to
understand and the changes in supply, demand and equilibrium price.
Price Quantity demanded Quantity supplied

1 50 10
2 40 20
3 30 30
4 20 40
5 10 50
The above table shows the demand and supply schedule of good. Changes in price are always
causing a change in supply and demand. As price increases there is a fall in the quantity
demanded. It means price and quantity demanded have negative relation. But rise in prices
has increased the supply of goods. The relation between price and supply of goods is positive.
Every time a change in price is causing some change in the supply as well as demand. At one
price ` 3 it can be observed that quantity supplied and demanded are equal. This is called
equilibrium price. This process is explained with the help of a diagram.
In the above diagram demand and supply are shown on OX-axis, price is shown on OY-axis. In
the diagram DD is the demand curve and SS is the supply curve. Both curves intersect at point
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E. It means the demand, supply are equal at OM level. So the equilibrium price is determined
as OP.
3. What is monopoly? State its features and how the price and output is determined under
monopoly?
Ans: Monopoly Market:
The word Monopoly is derived from two words ‘Mono’ and ‘Poly’. Mono means Single and
Poly means seller. Where there is an only one seller or one producer or one firm it is said to be
monopoly market.
The single seller supply the commodities to the entire market. The product supplied by
the monopolist have no close substitutes. There are some many restrictions for other
produces to enter into the market as a result monopoly has no competition in the market.
Features of Monopoly:
The monopoly market has the following features:
1. Single firm:
A single firm produces the commodity in the market there is only one seller or one
producer or one firm.
2. No close substitutes:
The products supplied by the monopolist will not have close substitutes in the market. A
consumer will not find a substitutes commodity for the monopoly products.
3. Strong barriers to enter:
New firms cannot enter in the production due to the certain restrictions in market i.e.
huge investment, lack of technology; patents etc. prevent the new firms to enter the market.
4. Firm and Industry are same:
As there is one firm in monopoly market there is no difference between firm and industry.
5. Price maker:
In this market the producer can determine the price of the commodity so the producer in
the market is said to be price maker.
6. Nature of AR & MR curves:
The average Revenue Curve (AR) and Marginal Revenue Curve (MR) both are slopes
downwards from left to right because when a seller wants to sell the more of output he must
reduce the price when the price is decreased both AR & MR are declining.
7. Price discrimination:
The monopolist can charge the different prices from the different customers for the same
thing or services. The price is not uniform as in the perfect market competition.
8. Maximum profits:
The main aim of monopoly is to earn to get the maximum profits.
Price and output determination:

In monopoly market as there is a single producer, he can control either the price of the
commodity or supply of the commodity. But he can’t control both at the same time. He can
increase the price by decreasing the output or he can sell more output by decreasing the
price. Maximization of profits is the sole objective of the monopolist. This can be shown by
the following diagram.
In the below diagram output is shown on OX-axis. Cost, Revenue and Price are shown on
OY-axis. In the diagram MR is the Marginal Revenue Curve MC is Marginal Cost Curve. It
intersects the MR curve at point E so the equilibrium level of output is determined as OM at
this level of output the average revenue is at point Q. So the price is determined as OP the
average cost is OS. Here AR > AC as the monopoly is to earn maximum profits.
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Abnormal profits = TR – TC
= O x AR – Q x AC
= OM x OP – OM x OS
= OPQM – OSRM
= PQRS.
4. Explain the features of monopolistic competition market?

Ans: Monopolistic Competition Market:
The concept of monopolistic competition was introduced by Prof. Chamberlin. It is a market
with many sellers for a product but the products are different in certain respects. The features
of monopoly and competition are combined in this market. Hence, it is called monopolistic
competition. Example: Cosmetics, Soaps etc.
Characteristics of Monopolistic Competition:

The main features are:
1. A considerable number of producers:
A commodity is produced by a considerable number of producers. Since there is more
number of producers no one controls the output in the market. Competition will be high
among the producers.
2. Product differentiation:
The commodity of each producer will be different from that of other producers. The
difference may be due to material used, color design, smell, packaging, trademark etc.
Because of this each product will have specific identification in the market.
3. Entry and exist:
Firms are allowed to enter into production and leave the market. When profits are high
new firms will join. In case of losses inefficient firms will leave.
4. Selling costs:
An important feature of this market is every firm makes expenditure to sell more output.
Advertisement through newspapers, journals, electronic media, sales representatives,
exhibitions, free sampling help to promote the sales. Lot of expenditure is made on these
items under this market.
5. Imperfect knowledge:
Buyers will have an imperfect knowledge about commodities. Sometimes products may
be the same but consumers think that a particular good is superior than another. Due to the
advertisements and other devices consumers purchase the commodities.
6. Price decision:
Each firm produces a commodity with small differences. It is due to this reason that a firm
will decide the price for its product. The demand curve for a firm will be downwards sloping
and more elastic.
Duopoly Market:
Where there are two sellers or two producers or two firms it is said to be duopoly market.
It is also one of the forms of oligopoly markets.
5. State the features of oligopoly market?

Ans: Oligopoly Market:
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The word oligopoly is derived from two Greek words oligo and pollien, oligo means “A few”,
Pollien means seller. Where there are a few firms or few producers or few sellers, it is said to
be oligopoly market.
For example: automobile industry, gas industry etc.
A market with a small number of producers is called oligopoly. The product may be
homogeneous or there may be differences. Since producers are a few each firm produces a
large portion of the output. It is a market with competition among the few. This market exists
in automobiles, electrical and cigarettes etc.
1. Less number of firms:
The numbers of producers are a few that is around fine in this market. Each one produces
a large part of the total output. He can control the output in the market. A firm can change
the price by supplying either more or less.
2. Interdependence:
In the oligopoly market the decisions of every producer affect other producers. This is due to
less number of producers in the market. A change in the decisions of a producer (output or
price) makes the other producers to change their decisions.
3. Selling costs:
Sometimes commodities are produced with small differences. Then each firm makes a
huge expenditure on advertisements. It is in the oligopoly that we can see the highest
expenditure on selling costs.
4. Uncertainty:
It will be difficult to guess what kind of demand curve will be there for a firm. Every time when
a producer changes his decision, other producers will also change their decision. Therefore, it
is not possible to expect price, output conditions to be the same in this market.
5. Rigid price:
In this market firms will not change the price, they follow a rigid price. A firm cannot
increase price because other firms will not raise their prices. The firm that increases the price
will be put to loss. If one firm reduces its price others will also do the same. Therefore, all the
firms will follow a price without making any changes in it. Hence it is called rigid prices.
6. Explain about the equilibrium of the firm under perfect market?

Ans: Equilibrium of the firm under perfect Market:
Equilibrium means constant position (or) unchanged position. The firm reached the
equilibrium position when it gets maximum output. To determine the maximum output two
conditions must be satisfied.
They are:
1. Marginal cost is equal to Marginal Revenue (MC = MR)
2. MC curve cuts the MR curve from below.
The equilibrium of the firm can be shown by the following diagram.
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In the above diagram output is shown on OX-axis. Costs and Revenues are shown on OY-
axis. In the diagram MR is the Marginal Revenue curve and MC is the Marginal Cost Curve. It
intersects the MR curve from below at point E1. It means at point E1 two conditions are
satisfied. So the equilibrium output is determined as M1.
Type of Equilibrium:
The equilibrium firm can be divided into two types. They are:
1. Short period equilibrium and
2. Long period equilibrium.
In the short period equilibrium the firm can get either abnormal profits or losses. But in the
long period equilibrium it gets only normal profits.
(a) Abnormal profits:

When the firm is in the short period equilibrium sometimes it can get abnormal profits.
This can be shown by the following diagram.
In the above diagram output is shown on OX-axis. Costs, Revenue and prices shown on
OY-axis. In the diagram MR is the Marginal Revenue curve MC is the Marginal Cost curve. It
intersects the MR curve from below at point Q. So the equilibrium output is determined as
OM at this output the price (AR) is determined as OP. The average costs (AC) is as here AR>AC.
So the firm can get abnormal profits.
Abnormal profits = TR – TC
= Q x P (AR) – Q x AC
= OM x OP – OM x OS
= OPQM – OSRM
= PQRS.
(b) Losses:
When the firm is in the short equilibrium sometimes it may get losses. This can be shown
by the following diagram.
In the above diagram output is shown on OX-axis costs, and revenues and prices are
shown on OY-axis. In the diagram MR is the Marginal Revenue Curve MC is the Marginal Cost
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Curve. It intersects the MR curve from below at point Q. So the output is determined as OM at
this level of output. The price (AR) is OP and the average costs (AC) are OS. Here AR < AC so
the firm will get losses.
Losses = TC – TR
= Q x AC – Q x P (AR)
= OM x OS – OM x OP
= OSRM – OPQM
= PQRS
Long period equilibrium – Normal Profits:

When the firm is in the long period equilibrium it gets only normal profits. This can be shown
by the following diagram.
In the above diagram output is shown on OX-axis Costs, Revenue, Price is shown on OY-
axis. In the diagram LMR is the long run Marginal Revenue curve. LMC is the long run Marginal
Cost Curve. It intersects the LMR from below at point Q. So the equilibrium output is
determined as OM at this level of output the price (AR) is OP. The average (AC) is also OP.
Here AR = AC. It means the total revenue (OPQM) is equal to total cost (OPQM). So the firm
will get only normal profits.
7. What is price discrimination? And state the types of price discrimination?

Ans: Price Discrimination under Monopoly:
If the seller charges different prices from the different customers for the same thing or
services, it is said to be price discrimination. It is possible only in monopoly market. Hence it is
called discriminating monopoly.
Classification of price discrimination:

Prof. Pigou has classified the price discrimination in to three types:
1. Price discrimination of first degree.
2. Price discrimination of second degree.
3. Price discrimination of third degree.
1. Price discrimination of first degree:

If the seller charges the different prices from the different customers on the basis of
paying capacity of the consumer, it is said to be price discrimination of first degree.
2. Price discrimination of second degree:
In this case the seller charges one price up to a limit of goods purchased, after that limit
he charges the another prices, it is called price discrimination of second degree.
3. Price discrimination of third degree:
Irrespective of the paying capacity of the consumer and quantity of the goods purchased, if
the seller charges the different prices it is said to be price discrimination of third degree. The
price discrimination of third degree was commonly prevailed in the society.
Conditions for price discrimination:
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A monopoly firm can sell the same product at two different prices to two different groups
of buyers. This type of price discrimination becomes possible under the following
circumstances:
(a) Different price elasticities of demand:
The monopolist charges higher price for the product in a market where price elasticity of
demand is relatively inelastic. On the other hand, he charges relatively lower price in a market
where the price elasticity of demand is relatively elastic.
(b) Tariff barrier:
If two markets are separated by a tariff wall, the monopolist can follow this principle of
price discrimination. For example, the monopolist can sell its product at a lower price in the
foreign market, and at a higher price in the domestic market.
(c) Geographical distance between the markets:

Price discrimination is also possible when two markets are separated from one another by
geographical distance. In this case, the monopolist can sell its product at a lower price in a
distant market and at higher price in the local market.
(d) Impossibility of resale of a product (particular service items):
If it is not possible on the part of any buyer to resale the product sold by the monopolist,
then the monopolist can easily follow the policy of price discrimination. This happens
particularly in case of service items. For example, a renowned doctor can charge different fees
for rendering similar service to two different patients.
(e) Ignorance of the consumers:
If the consumers remain ignorant about the difference in prices of the same product in
two different markets, then also the monopolist can easily follow the policy of price
discrimination.
(f) Typical behavior of the consumers:
In some cases, a group of consumers consider higher price as an indicator of higher quality
(the so called Veblen effect). Such typical behavior of the consumers creates an opportunity
for the monopolist to follow the policy of price discrimination.
8. Equilibrium condition under monopolistic competition market?

Ans: Demand curves:
There are two types of the demand curves under monopolistic competition market.
1. Perceived demand curve.
2. Proportional demand curve
1. Perceived demand curve:

This demand curve shows the different combinations between quantity demand and price
such that neither of the firms as any further initiative to deviate from their decisions.
2. Proportional demand curve

This demand curve captures the impact of the all firms simultaneously changing the same
price and hence it takes into accounts the affects of the actions of the rivals.
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When the perceived demand curve (dd) and proportional demand curve (DD) are
intersect, then the price is determined in monopolistic competition market.
Equilibrium condition under monopolistic competition:

Like the perfect competition market the firm in this market also satisfies the two
conditions to reach the equilibrium position. They are
Marginal cost = marginal revenue (MC = MR)
MC curve cuts the MR curve from below
TR = Q × P(P (AR) TC = Q × AC
= Oq × OP = Oq × Oc
= OPaq = Ocbq
Abnormal profit = Pabc
In the long run the firms enjoy super normal profits. It operates less than its full utilization
level. This call for the emgerance of the excise capacity in the market.
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According to the above diagram the difference between qmc and qpc captures the extent
of excess capacity.
9. Pricing strategies under oligopoly market?

Ans: 1. Cournot’s Model:
According to Cournot each duopolist believes that regardless of his actions and they effect
upon the market of the product the other will go on producing the same commodity. Cournot
output is two- third of the competitive output and the price is two – third of most profitable
i.e., monopoly price.
2. tackleberg Model:
In this case, the producer under duopoly structure incorporate the decision level of his
rival, incorporates in its own profit margin.
3. Bertrand Model:
According to this model each producer can always lower the price until price is equal to cost
of production.
4. Edgeworth Model:
According to this model each duopolist believe that his rival will continue to change the same
price as he just doing irrespective of what he himself sets in.
5. Collusive Oligopoly:
According to this model a cartfle is formed when firms jointly fixes the price and output
with a view to maximize joint profit.
For example: OPEC countries form a cartel.
10. Explain about different pricing strategies?

Ans: Pricing Strategies:
• Cost-plus pricing:
Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the
product and adds on a percentage (profit) to that price to give the selling price.
• Limit pricing:
A limit price is the price set by a monopolist to discourage economic entry in to a market. The
limit price is often lower than the average cost of production of just low enough to make
entering not profitable.
• Penetration pricing:
Setting the price low in order to attract customers and gain market share. The price will be
raised later once this market share is gained.
• Price discrimination:
Setting a different price for the same product in different segments to the market. For
example, this can be for different classes, such as ages, or for different opening times.
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• Psychological pricing:
Pricing designed to have a positive psychological impact. For example, selling a profit at `
3.95 or ` 3.99, rather than ` 4.000.
• Dynamic pricing:
A flexible pricing mechanism made possible by advances in information technology, and
employed mostly by internet based companies.
• Price leadership:
An observation made of oligopolistic business behavior in which one company, usually the
dominant competitor among several, leads the way in determining prices, the others soon
following.
• Target pricing:
Pricing method where by the selling price of a product is calculated to produce a particular
rate of return on investment for a specific volume of production. The target pricing method is
used most often by public utilities, like electric and gas companies, and companies whose
capital investment is high, like automobile manufactures.
• Absorption pricing:
Method of pricing in which all costs are recovered. The price of the product includes the
variable cost of each item plus a proportionate amount of the fixed costs and is a form of cost-
plus pricing.
• High-low pricing:
Method of pricing for an organization where the goods or services offered by the
organization are regularly priced higher than competitors, but through promotions,
advertisements, and coupons, lower prices are offered on key items.
• Marginal –cost pricing:

In business, the practice of setting the price of a product to equal the extra cost of producing
an extra unit of output.
I. List of question
1. What is market? And explain the various forms of market?
2. Define perfect competition market? And state how the price is determined under this
market?
3. What is monopoly? State its features and how the price and output is determined under
monopoly?
4. Explain the features of monopolistic completion market?
5. State the features of oligopoly market?
6. Explain about the equilibrium of the firm under perfect market?
7. Equilibrium condition under monopolistic competition market?
8. What is price discrimination? And state the types of price discrimination?
9. Pricing strategies under oligopoly market?
10. Explain about different pricing strategies?

1. Which of the following is/are an essential feature of the market
(a) Buyers (b) Sellers (c) Price (d) All the three
2. In the long run price is governed by ………….
(a) Cost of Production (b) Demand supply forces
(c) Marginal utility (d) None
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3. In the long run a firm in perfect competition earns
(a) Normal profit only (b) Abnormal profit
(c) Average profit of past five years (d) 12.33% profits on capital employed
4. A firm faces the shut down situation when
(a) Price is less than average variable cost
(b) Price is more than the average variable cost (c) Price is equal to fixed cost
(d) Price is more than the average fixed cost
5. A firm that makes profit in excess of normal profit is earning
(a) Economic profit (b) Costing profit (c) Normal profit (d) Super normal profit
6. The market state that satisfy all the essential features of a perfect competitive market
except identity of product is known as
(a) Oligopoly (b) Duopoly (c) Monopoly (d) Monopolistic competition
7. In the short run if the price is above the average total cost in a monopolistic competitive
market, the firm makes
(a) Profits and new firms join the market (b) Profit and bar entry to new firms
(c) Makes losses and exit the market (d) Quick profit and disappears
8. Which of these is associated with a monopolistic competitive market –
(a) Product differentiation (b) Homogeneous Product
(c) Normal in short run (d) Single buyer
9. In a competitive market ………. is the price maker
(a) Firm (b) Industry (c) Consumer (d) Trade association
10. A Monopoly demand curve is
(a) Same as its average revenue curve (b) Same as its supply curve
(c) Both ‘a’ and ‘b’ (d) None of the above
11. Which is the first order condition for the profit of a firm be maximum?
(a) AC = MR (b) MC = MR (c) MR = AR (d) AC = AR
12. The AR curve and industry demand curve are identical
(a) In case of monopoly (b) In case of oligopoly
(c) In case of monopolistic competition (d) In case of perfect competition
13. OPEC is an example of
(a) Perfect competition (b) Monopolistic competition
(c) Monopoly (d) Cartel
14. ____________ means absence of competition

(a) Perfect Competition (b) Monopoly
(c) Imperfect Competition (d) Discrimination
15. In the long-run, a firm in perfect competition earns _________________
(a) Normal Profit only (b) Abnormal profit
(c) Average profit of past 5 years (d) 12.33 per cent, profit on capital
employed
16. Oligopoly means _________
(a) Single seller (b) Few sellers (c) Large numbers of sellers (d) No buyers
17. Penetration Pricing is adopted by following a _______________
(a) Low Price (b) High Price (c) Dual Price (d) Support Price
18. On the basis of area, markets are classified into ____________ types
(a) 2 (b) 3 (c) 4 (d) 5
19. Which of the following does not characterize monopolistic competition?
(a) Product differentiation (b) Many producers
(c) Absence of advertising (d) Partial control over price
20. Pricing for selling the same commodity at different selling prices is known as _______
(a) Skimming Pricing (b) Differential Pricing
(c) Penetration Pricing (d) Cost-plus Pricing
21. In a perfect competition, a firm earns super normal profit when the AR of the firm
_______ the AC of the firm.
(a) Equals to (b) Exceeds
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(c) Is lower than (d) Neither exceeds nor is lower than
22. ____________ refers to the market situation where there is one seller and there is no
close substitute to the commodity sold by the seller.
(a) Perfect Competition (b) Monopoly (c) Oligopoly (d) Monopolistic Competition
23. On the basis of time element, markets can be classified into _______________ types.
(a) 2 (b) 3 (c) 4 (d) 5
24. _______Competition exists when the basic features of Perfect Competition are not
present.
(a)Pure (b) Perfect (c) Imperfect (d) All of the above
25. On the basis of competition, markets are classified into _____________ types.
(a) 2 (b) 3 (c) 4 (d) 5
26. ___________ means absence of competition.
(a) Monopoly (b) Perfect (c) Imperfect (d) Oligopoly
27. In a competitive market, _____________ is the price-marker.
(a) Firm (b) Industry (c) Consumer (d) Trade association
28. Long-run equilibrium price is known as ___________
(a) Market Price (b) Reserve price (c) Normal Price (d) Support price
29. Which of the following is one of the assumptions of perfect competition?
(a) Few buyers and few sellers (b) Many buyers and few sellers
(c) Many buyers and many sellers (d) All sellers and buyers are honest
30. In monopoly, the relationship between average and marginal revenue curves is as follows:
(a) AR curve lies above the MR curve (b) AR curve coincides with the MR curve
(c) AR curve lies below the MR curve (d) AR curve is parallel to the MR curve
31. Which of the following is not a feature of perfect competition?
(a) Large number of buyers and sellers (b) Small number of buyers and sellers
(c) Free entry and exit (d) Goods is homogeneous
32. In which of the following market structure is the degree of control over the price of its
product by a firm very large?
(a) Imperfect competition (b) Perfect competition
(c) Monopoly (d) In A and B both
33. Pure oligopoly is based on the ___________ products
(a) Differentiated (b) Homogeneous (c) Unrelated (d) None of the above
34. A firm earns normal profit when:
(a) When AR = AC (b) When MR = MC
(c) When MR = AR = AC =MC (d) None of the above
35. There is no difference between firm and industry in case of:
(a) Pure Monopoly (b) Pure Oligopoly (c) Perfect competition (d) duopoly
36. The goods which are perishable will have _________ market
(a) Huge (b) Very long period (c) Long period (d) Very short period
37. In a perfectly competitive market, the demand curve is –
(a) Relatively inelastic (b) Unitary elastic (c) Relatively elastic (d) Infinitely elastic
38. Perfect competitive firm are –
(a) Price searchers (b) Price makers (c) Price discriminators (d) Price taker
State the sentence true or false:

1. Railways is an example of perfect market ( )
2. Sugar cane is an example of monopolistic competition ( )
3. Free entry to exit is not the feature of monopoly ( )
4. When mc=mr the firm will get maximum profits ( )
5. The firm in monopoly is price taker ( )
6. Price discrimination is possible in monopoly market only ( )
7. Pure oligopoly is one where there are few sellers producing homogeneous product ( )
8. Kinky demand curve is the feature of monopoly ( )
9. The firm in monopolistic competition earns abnormal profits in long run ( )
10. The firm under perfect market earns normal profits in short ( )
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11. Average revenue curve under perfect competition is vertical straight line ( )
12. On the basis of time element, markets are classified into two types ( )
13. In perfect competition, there is large number of firms producing heterogeneous goods ( )
14. The concept of Monopolistic Competition was introduced by Adam Smith ( )
15. In perfect market AR = MR curve is parallel to X – axis ( )
16. In perfect market AR>MR ( )
17. The firm under perfect market earns normal profits in short ( )
V. Matching
1. Proportional demand curve () A. less price
2. Price discrimination () B. duopoly
3. Homogeneous product () C. advertisements
4. Interdependence () D. high price
5. Two firms () E. Monopoly
6. Limit price () F. long period
7. Skimming price () G. perfect market
8. Selling costs () H. price discrimination
9. Tariff barriers () I. monopolistic completion market
10. AR=MR=P=MC () J. oligopoly
VI. Give the answer in one or two sentences
1. What is market
Ans: The term market refers to a system by which the buyers and sellers of a commodity can
came into touch with each other either directly or indirectly for the exchange of a commodity
or service.
2. Penetration pricing
Ans: Setting the price low in order to attract customers and gain market share. The price will
be raised later once this market share is gained.
3. Dynamic pricing
Ans: A flexible pricing mechanism made possible by advances in information technology, and
employed mostly by internet based companies.
4. Perceived demand curve

Ans: Perceived demand curve shows the different combinations between quantity demand
and price such that neither of the firms as any further initiative to deviate from their
decisions.
5. Monopoly
Ans: The word Monopoly is derived from two words ‘Mono’ and ‘Poly’. Mono means Single
and Poly means seller. Where there is an only one seller or one producer or one firm it is said
to be monopoly market. The single seller supply the commodities to the entire market the
product supplied by the monopolist is not have close substitutes. They are some many
restrictions for other produces to enter into the market as a result monopoly has no
competition in the market.
6. Product differentiation
Ans: The commodity of each producer will be different from that of other producers. The
difference may be due to material used, colour design, smell, packaging, trademark etc.
Because of this each product will have specific identification in the market.
7. Selling costs
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Ans: An important feature of this market is every firm makes expenditure to sell more output.
Advertisement through newspapers, journals, electronic media, sales representatives,
exhibitions, free sampling help to promote the sales. Lot of expenditure is made on these
items under this market.
8. Cost plus pricing

Ans: Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing
the product and adds on a percentage (profit) to that price to give the selling price.
9. Collusive oligopoly
Ans: In oligopoly market the firms formed in to a cartel to fix the price and output with a view
to maximize joint profits. It is called collusive oligopoly.
For example: OPEC countries form a cartel to jointly control the supply of oil like a pure
monopolist and maximize joint profits.
10. Price leadership:

Ans: An observation made of oligopolistic business behavior in which one company, usually
the dominant competitor among several, leads the way in determining prices, the other s
soon following.
Answers:
1. (D) 2. (A) 3. (A) 4. (A) 5. (D) 6. (D) 7. (A) 8. (A) 9. (B) 10. (A)

1. price mechanism 2. monopolistic competition 3. Positive 4. demand curve
5. monopolistic competition 6. Monopoly 7. Oligopoly 8. Oligopoly 9. Less
10. More
IV. State the sentence true or false:

1. (F) 2. (F) 3. (T) 4. (T) 5. (F) 6. (T) 7. (T) 8. (F) 9. (T) 10. (F)
V. Matching:
1. I 2. E 3. G 4. J 5. B 6. A 7. D 8. C 9. H 10. F
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STUDY NOTE 6
MONEY
1. What are the difficulties of barter system?

Ans: Before the introduction of money barter system was in vogue or prevailed. If the goods
are exchanged for the goods it is said to be barter system. There are so many inconveniences
in barter system.
Difficulties of the Barter System:

The difficulties of the barter system which may be enumerated as follows:
1. Lack of coincidence of wants.
2. Lack of store of value.
3. Lack of divisibility of commodities.
4. Lack of common measure of value.
5. Difficulty in making deferred payments.
1. Lack of coincidence of wants:

Under the barter system the buyer must be willing to accept the commodity which the seller
is willing to offer in exchange. The wants of both the buyer and the seller must coincide. This
is called double coincidence of wants.
2. Lack of store of value:
Some commodities are perishables. They perish within a short time. It was not possible to
store the value of such commodities in their original form under the barter system. They
should be exchanged before they actually perish. Otherwise, they would not be available for
exchange when the need actually arises in future.
3. Lack of divisibility of commodities:
Depending upon its quantity and value, it may become necessary to divide a commodity into
small units and exchange one or more units for other commodity. But all commodities are not
divisible. This is particularly true in the case of animals.
4. Lack of common measure of value:
Under the barter system there was no common measure of value. To make exchange possible,
it was necessary to determine the value of every commodity in terms of every other
commodity.
5. Difficulty in making deferred payments:
Under barter system future payment for payment for present transaction was not possible,
because future exchange involved some difficulties. For examples, suppose it was agreed to
sell specific quantity of rice in exchange for a goat on a future date keeping in view the
present value of the goat. But the value of goat may decrease or increase by that date.
2. Define money and explain the function of money.

Ans: Functions of money
Money plays a significant role in the modern economic life of the human beings.
Evolution of Money:
The term ‘Money’ was derived from the name of Goddess “Juno Moneta” of Rome.
Definition of Money:
Money was invented to overcome the difficulties of the barter system. Several economists
defined money in several ways:
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1. Robertson: Robertson defined money as “anything which is widely accepted in
payments for goods or in discharge of other kinds of business obligations”.
2. Seligman: According to Seligman’s definition, “Money is one that possesses general
acceptability”.
3. Walker: According to Walker, “Money is what money does”.
6.2 FUNCTIONS OF MONEY
Functions of Money:
Money has many important functions to perform. These functions may be classified as
follows:
1. Primary Functions.
(a) Medium of Exchange.
(b) Measure of Value.
2. Secondary functions
(a) Store of value.
(b) Standard of deferred payments.
(c) Transfer of money.
3. Contingent functions.
(a) Measurement and distribution of national income.
(b) Money equalizes marginal utilities/productivities.
(c) Basis of credit.
(d) Liquidity
1. Primary functions:
The primary functions of money are really the technical and important functions of
money. They are of two types:
(a) Medium of Exchange:
Money serves as a medium of exchange. Money facilitates exchange of commodities
without double coincidence of wants. Any commodity can be exchanged for money. People
can exchange goods and services through the medium of money.
(b) Measure of Value:
The value of each commodity is expressed in the units of money. We call it the price. In
view of this function of money, the values of different commodities can be compared and the
ratios between the prices of different commodities can be determined easily.
2. Secondary functions:
Money has the following secondary functions:
(a) Store of value:
The value of commodities and services can be stored in the form of money. Certain
commodities are perishable. If they are exchanged for money before they perish, their value
can be preserved in the form of money.
(b) Standard of deferred payments:
Money serves as a standard of deferred payments. In the modern economies most of the
business transactions take place on the basis of credit. An individual consumer or a business
man may now purchase a commodity and pay for it in future. Similarly one can borrow certain
amount of money now and repay it in future.
(c) Transfer of money:
Money can be transferred from one person to another at any time and at any place.
3. Contingent functions:
Besides the primary and secondary functions, money has certain contingent functions
also. They may be stated as follows:
(a) Measurements and distribution of national income.
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Nations income of a country can be measured in money by aggregating the value of all
commodities. Similarly national income can be distributed to different factors of production
by making payments to them in money.
(b) Money equalizes marginal utilities/productivities:
The consumers can equalize the marginal utilities of different commodities purchased by
them with the help of money. They can thus maximize their satisfaction. Similarly the firms
can also equalize the marginal productivities of different factors of production and maximize
their profits.
(c) Basis of credit:
Credit is created by banks from out of the primary deposits of money. The supply of credit
in an economy is dependent on the supply of nominal money. It is not possible to create credit
if there is no reserve money.
(d) Liquidity:
Money is the most important liquid asset. In terms of liquidity it is superior to all other
assets. Money is cent percent liquid.
3. Explain the forms of money.

Ans: Money supply includes all money in the economy. The components of money supply may
vary from country to country. Broadly speaking, money supply composes of the following:
1. Currency issued by the Central Bank.
2. Demand deposits created by commercial banks.
1. Currency issued by the Central Bank:

In any country the Central Bank issues currency. Currency consists of paper notes and
coins. In India Reserve Bank of India which is the Central Bank of the country issues notes in
the denominations of Rs. 1000, ` 500, ` 100, ` 50, ` 20, ` 10 and ` 5 and ` 2. The one rupee note
and coins are issued by the Finance Department of the Government of India.
2. Demand deposits created by Commercial banks:

Bank deposits are a prominent component of money supply. Commercial banks create
credit from the primary deposits of money received from the public. Credit is created in the
form of deposits called derived or secondary deposits.
3. Explain about Fisher’ theory

Ans:1. Quantity theory by Irving Fisher:
The quantity theory of money explains about the value of money. Irving fisher gave an
equation to determine the value of money.
Irving Fisher used an equation [MV = PT]
MV = money supply.
PT = money demand.
M = Money supply issued by the legal authority
V = Velocity of money
P = Price level
T = total output
Fisher used the equation to show the relationship between money supply and price level
as direct and proportional. The rate of change in money supply (dm/m) is equal to rate of
change in P (dp/p).
Main points:
1. There is a direct proportion relationship between money supply and price level.
2. There is an inverse relationship between money supply and value of money.
3. There is an inverse relationship between price level value of money.
Assumptions of fisher equations:-
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1. (v) velocity of money is constant.
2. Gross national product (T) is also constant
3. This theory assumes that money demand for transaction purpose only.
Criticisms:
1. Fisher’s equation is abstract and mathematical truism. It does not explain the process by
which m affects P.
2. It is presumed that entire M is used up in buying T instantly. It is unreal. No one spends all
money the moment he earns it.
3. The concept full employment is myth. There is natural rate of unemployment in every
country.
4. Even with full employment, a country can rise national output by bringing those factors
which are not available within economy from abroad.
5. It is presumed that money is used for transactions only. Hence the theory is often referred
to as cash transaction theory. This ignores the other roles of money.
5. Explain about cash balance approach.

Ans: Quantities theory of money cash balance approach (or) Cambridge equation:-
Cambridge university professors gave another equation which explains the value of
money i.e.
M = PKT
M = money supply for a specific period of time
P = Price level
K = cash balance, it is the part of total income
T = total output
Meaning of K:
The part of money supply which is kept in the form of cash to meet the unforeseen
expenditure is called “K”. When M & T are constant if there is a change in the ‘K’ that leads to
the change in price level. If K is more the value of money should increase, if K is less the value
of money also less.
6. State about quantity theory of Money by Keynes.

Ans: Quantity theory by Keynes:
According to J.M. Keynes the money supply effects the rate of interest when the money
supply increases rate of interest will be decreased. It leads to the increase of investments then
level of employment, income, demand, price level etc., when the price level increases there is
a decrease in the value of money.
According to Keynes the rate of interest place a dominant role in determination of value
of money.
The Keynesian version of the Quantity Theory integrates monetary theory with the
general theory of value.
INFLATION
7. Define the inflation and explain the causes for inflation?

Ans: In a broader sense, the term inflation refers to persistent rise in the general price level
over a long period of time. Some of the important definitions are given below:
Definition:
Crowther: Crowther defined as a state in which the value of money is falling, that is the prices
are rising.
Samuelson: According to Samuelson, “Inflation denotes a rise in the general level of prices”.
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Causes of Inflation:
Primary Causes:
1. When demand for a commodity in the market exceeds its supply, the excess demand
will push up the price (‘demand-pull inflation’).
2. When factor prices rise, costs of production rise (‘Cost –push inflation’)
Let us now discuss in detail the various causes that may bring about inflation –
Increase in public spending:

Government’s spending is an important part of total spending in any modern economy. It
is an important determinant of aggregate demand. In less developed economies, government
expenditure has shown an upward trend. This has created inflationary pressure on the
economy.
Deficit financing of government spending:-

Government spending increases beyond what can be financed by taxation. In order to be
able to incur the extra expenditure, the government resorts to deficit financing. For instance,
it prints money and spends it. This adds to the pressure of inflation.
Increased velocity of circulation

Total use of money = money supply by the government x velocity of circulation of
money. In boom phase, people speed money at a faster rate. The velocity of circulation of
money is increases.
Population growth:
It increases total demand in the market. The pressure of excess demand will create
inflation.
Hoarding:
Excess demand is sometimes artificially created by hoarders. They stockpile
commodities. They do not release them to the market. This leads to excess demand and
inflation.
Genuine shortage:
If the factors of production are in short supply, production will be affected. Supply will be
less than demand, prices will rise.
Exports:
If the total output of a commodity is not sufficient to meet both domestic and foreign
demand. Then exports will create inflation in the domestic economy.
Trade unions:
By demanding an increase in the wage rate, it increase the cost of production.
Tax reduction:
Governments sometimes reduce taxes to gain popularity. This leaves more money in
people’s hands. This leads to inflation if there is no corresponding increase in production.
Imposition of indirect taxes:

Government may imposes indirect taxes (such as excise duty, value-added tax etc.). Then
producers of sellers raise the product prices to keep their profits unchanged.
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Price-rise in international market:
The imported price of some commodities or factors of production may rise in the world
market. It would lead to inflation in the domestic market.
Non-economic reasons:
For instance, at times of natural calamities (flood) crops are destroyed, reducing the
supply of agricultural products. Prices of these commodities tend to increase.
8. Explain the Impact of inflation?

Ans: Inflation has effect on all economic activities in the economy. These may be explained as
follows:
On Production:
There may be positive and negative impact of inflation on production. It depends on the rate
of inflation or type of inflations. Mild inflation stimulates production as it increase the profit
margin of entrepreneurs. As long as there are unemployed resources output can be increased.
This will increase employment and output as well. High inflation rate or hyper inflation
hinders production. Inflation discourage savings. This affects the capital information which in
turn affects the production.
On distribution:
The impact of inflation is not uniform on all section of people. It affects certain sections of the
people adversely while certain other sections gain because of inflation. This can be elaborated
as follows:
Fixed income groups:

People belonging to fixed income groups suffer due to inflation because their income does
not increase as prices of commodities rise.
Working class:
Workers & wage earners in the informal sectors normally work for fixed incomes even
otherwise their wage do not rise and when prices arise such people suffer because of
inflation.
Debtors and Creditors:

Inflation results in decline in the value of money. Therefore creditors lose the value of
money is higher when they lent and less when they are repaid. But debtor gain because the
value of money is high when they borrowed but low when they repay.
Consumers and Entrepreneurs:

Consumers lose but entrepreneurs gain because of inflation.
Social impact:
Economic inequality leads to unequal opportunities in matters of health, education and
employment. This results in social injustice.
Political effect:
Inflation widens social and economic disparities which cause inflation among the
sufferers. This provides opportunity for political movements and if the government is not
responsive, the movements may threaten the stability of government.
9. Explain the Types of Inflation?

Ans: Inflation is divided into different types based on rate of inflations and the causes of
inflation. They are detailed below.
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A. Based on rate of inflation:
Based on rate of inflation it may be categorized into four types as follows:
a. Creeping inflation:
When rise in the prices is very slow and small, it is called creeping inflation. The rate of
inflation does not exceed 3% per annum. It is the mildest form of inflation. It is not harmful.
b. Moderate inflation:
When the rate of inflation in the range of 4 – 10 per cent per annum, it is called moderate
inflation. This is harmful to the economy.
c. Gallaping inflation or Hyper inflation:
If the inflation rate exceeds 10 percent, galloping inflation occurs. It may also be called
hyper inflation.
B. On the basis of Cause:

On the basis of cause, inflation is classified into two types.
a. Demand-Pull inflation:
Inflation, caused by the increase in the aggregate demand for commodities over
aggregate supply is called demand-pull inflation. Aggregate demand increases due to increase
in the income level of people caused by increased public spending and economic
development.
If the demand is responsible for the rise of price level it is said to be demand pull inflation.
Diagram:
b. Cost Push inflation:

Inflation is caused by rise in the cost of production is called cost-push inflation. Cost of
production may rise due to increase in wages forced by trade unions or government.
If the cost of production is responsible for the rise of the price level it is said to be cost
push inflation. It is also called supply side inflation.
Diagram:
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C. On the basis of Government:
a. Open inflation:
When the government does not control the prices through administrative measures and
leave it to the market forces such type of inflation is called open inflation.
b. Suppressed inflation:
When the government imposes restrictions or controls price through administrative
measures, suppressed inflation exists. When the government lifts the control, open inflation
reappears.
D According to Keynes there are two types of inflation

1. True inflation
2. Semi inflation
True inflation is formed after the full employment situation, semi inflation is formed
before reaching the full employment.
EFFECT OF THE INFLATIONS:-

Inflationary pressure in an economy my generate goods effects on the economy,
particularly in case of ‘creeping’ or ‘walking’ inflation.
Favorable impacts:
(a) Higher profits: Profits of the producers are generally favorable affected by inflation,
because they can sell their products at higher prices.
(b) Higher investment: The entrepreneurs and investors get added incentives to invest in
productive activities during inflation, since they can earn higher prices.
(c) Higher production: If productive investment grows during inflation, it would lead to
higher production of various goods and services in the economy.
(d) Higher employment and income: Increase in the output of different goods during
inflation would also means increasing demand for various factors of production. So. It is
expected that employment and income opportunities will also increase during inflation.
(e) Gain for the borrowers:
Inflation means a decrease in the value or purchasing power of money. If the rate of
interest to be paid by the borrower is less than the inflation rate, the borrower will gain,
Because the real value of the money returned by the borrower is actually less than that of the
money borrowed earlier.
Unfavorable Impacts:
(a) Fall in the real income of fixed – income groups:
Real income means purchasing power of money income [Real income= (money
income)/(price level).] Given the money income of the fixed- income groups, the real income
will fall during inflation. Hence, inflation affects workers, salaried people and pension-earners
adversely.
(b) Inequality in the distribution of income:
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The profit incomes of business men and entrepreneurs increasing during inflation while
the real income of the common salaried people declines. So inequality in the distribution of
income become acute during inflation.
(c) Upsets the planning process:
When prices of goods, materials, and factor services increase continuously, the more
money has to be spent for the completion of any investment project taken up during any
planning period. If more financial resources cannot be raised by the Government (through
savings or taxation), plan targets are to be curtailed.
(d) Increase in speculative investment:
If the price level rises at a fast rate, speculative investment (say, purchasing shares, land,
gems, etc., just for speculative purposes) may increase in the economy for earning quick
profits. These types of investments do not help in the creation of productive capital in the
economy.
(e) Harmful impact on capital accumulation:
If the price-rise becomes chronic, people prefer goods to money (because the real value
of money will fall in future). They also prefer immediate consumption to consumption in
future. So, their desire to save is reduced. When both ability and willingness to save become
less, a smaller amount of fund becomes available for further investment. As a result, in
creates a harmful impact on capital accumulation, since capital accumulation in an economy
depends on the growth of investment.
(f) Lenders will lose:
We have already indicated that borrowers will gain during inflation. For this same reason,
lenders will loser during inflation. Because, they are actually receiving an amount having lower
value (or purchasing power) than before.
(g) Harmful impact on export income:
If the prices of export items also increase during inflation, their demand in the foreign
market may fall. This leads to a fall in the export income of a country.
10. Explain the Measures to Control inflation?

Ans: Measures to Control Inflation:
I. Monetary Policies:
It is the policy formulated by the RBI and implemented by the RBI to control the supply of
the money in the economy. For this the RBI uses the following weapons
1. Bank rate
2. Open market operations
3. CRR (cash reserve ratio)
1. Bank rate :
The rate of interest charged by RBI from the commercial banks for the money lending
[longterm] is called bank rate.
2. Open market Operations:
Buyings and selling’s of the government bonds and securities to the public openly is called
open market operations.
Ex: Indera vikasa patram, post office saving bonds.
3. Cash reserve ratio (CRR)
Every commercial bank should maintain the cash balances in the form of reserves in their
primary deposits. It is called cash reserve ratio. CRR is decided by RBI
II. Fiscal Policy:

It is the policy formulated by the government and implemented by the government to
control the purchasing power of money. This is called fiscal policy. Any measurement relating
to
1. Public revenue 2.Public Expenditure 3.Public debt ………. come under the Fiscal
policy
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III. Direct control: Fixing the limit to the prices.
IV. Other measures:

Government has to take several steps as given below to control inflation:
a. Importing the goods which are in short supply in the country.
b. Introducing rationing and quota system in case of mass consumption goods where supply
is inadequate to improve their distribution among all the needy sections of the people.
c. Controlling prices and eliminating black markets.
d. Taking steps to increase production in the long run.
Deflation:
A continuous falling in the price level is called deflation.
Inflation: ↑ Price (p) unemployment ↓
Deflation: ↓ Price (p) unemployment ↑
Stagflation: ↑ Price (p) unemployment ↑
11. What are the components of money supply (or) monetary aggregates?
Ans: Monetary aggregates:
In India money supply is measured in terms of the following monetary aggregates:
M1 = Currency + Demand deposits + Other deposits.
M2 = M1 + Time liability portion of savings deposits with banks + Certificates of Deposits
issued by banks + term deposits maturing within one year.
M3 = M2 + term deposits over one year maturity + call/term borrowings of banks.
Value of Money:
The purchasing power of money is called value of money. It is nothing but exchange value.
How much of goods and services can be obtained in exchange of a unit of money is called
value of money. The value of money mainly depends upon price level. The inverse value of P is
called value of money (1/P)
Types of value of money:

1. Internal exchange value
2. External exchange value
1. Internal Exchange Value:

How much goods and services can be obtained in exchange of a unit of money
domestically is called internal value of money.
2. External Exchange value:
How much foreign currency can be obtained in the exchange of a unit of domestic
currency is called external exchange value.
Forms of money:
1. Cash money and credit money.
2. Other financial assets (NBFI) e.g.:- Units of UTI, insurance policy etc.
3. Paper money and coins
4. Near money (or) money substitutes (bank cheque)
Gresham’s law:
The Law states that bad money drives good money out of circulation. This is true is case of
bimetallism where two metal standard (gold and silver) operate side by side. In such a case
one metal currency drives the other out of circulation. It also means cheap money drives out
dear money. If a country uses both paper money as well as metal money, People will use the
paper and hold the metal money.
I. List of question:
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1. What are the difficulties of barter system?
2. Define money and explain the function of money.
3. Explain the forms of money.
4. Explain about Fisher’ theory.
5. Explain about cash balance approach.
6. State about quantity theory of Money.
7. Define the inflation and explain the causes for inflation?
8. Explain the Impact of inflation?
9. Explain the Types of Inflation?
10. Explain the Measures to Control inflation?
12. What are the components of money supply (or) monetary aggregates?
II. Choose the correct answer

1. Which of the following is near money?
(a) Bill of exchange (b) Saving bonds (c) Gilt edged securities (d) All the three
2. Optional money is a
(a) Legal tender money (b) Non-legal tender money
(c) Limited legal tender money (d) Full bodied money
3. Which of the following function does money serve when used to measure the prices of
different goods and services?
(a) Store of value (b) Medium of exchange
(c) Standard of value (d) Display of power
4. Which of these affects the demand for money?
(a) Real income (b) Price level (c) Rate of interest (d) All the three
5. Which of these would lead to fall in demand for money?
(a) Inflation (b) Increase in real income
(c) Increase in real rate of interest (d) Increase in wealth
6. Supply of money refers to
(a) Total money held by the public (b) Total money held by RBI
(c) Total money with all the commercial banks and RBI
(d) Total money in Government account
7. Cost push inflation arises due to
(a) Persistent rise in factor cost
(b) Mismatch between demand and supply of commodities
(c) Combine phenomena of demand pull and cost-push inflation.
(d) Increase in price of precious metal
8. Which of these is one of the causes of inflation?
(a) Increase in public expenditure (b) Deficit financing
(c) Increase in administrative prices (d) All the three
9. Deficit financing means
(a) Financing budgetary deficit by borrowing
(b) Financing budgetary deficit by printing money
(c) Both (d) None
10. Inflationary conditions may co-exist with which of the following situation
(a) Increase in factor cost (b) Increase in employment opportunities
(c) Growth in GDP and exports (d) All the three
11. The relationship between money supply and price level is
(a) Inverse (b) Neutral (c) Proportional (d) non-proportional
12. Cash Balance Approach was given by
(a) I. Fisher (b) J.M. Keynes
(c) G. Crowther (d) Cambridge University Professors
13. The primary functions of money are of ________ types
(a) 2 (b) 3 (c) 4 (d) 5
14. The money supply affects the rate of interest; when the money supply increases, rate of
interest will be decreased. It is explained by ____________________
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(a) Keynes (b) Walker (c) Robbins (d)
Crowther
15. Cash Money is created by the _________________
(a) Central bank of a Country (b) Commercial Banks
(c) State Bank of India (d) Co-operative Banks
16. “Money is what money does”. This definition was given by _________________
(a) Adam Smith (b) Walker (c) Robbins (d) Robertson
17. The __________ State that bad money drives good money out of circulation.
(a) Law of Demand (b) Law of Supply
(c) Gresham’s Law (d) Demand Schedule
18. Quantity Theory of Money was explained by __________
(a) Fisher (b) Keynes (c) Crowther (d) Samuelson
19. Bonds and Government Securities refer to ___________ money.
(a) Near (b) Call (c) Optional (d) None of the above
State the sentence True (or) false

1. According to walker, money is what money does ( ).
2. Money is treated as means of trade and commerce ( )
3. Examples of NBFI are cash money and credit money ( )
4. According to Cambridge equation if ‘K’ is more the value of money should increase ( )
5. According to Keynes the rate of interest cannot decide the value of money ( )
6. There is a direct relationship between price level and value of money ( )
7. During the inflation period borrowers will gain ( )
8. Public expenditure come under the money policy ( )
9. Tax policy come under Fiscal policy ( )
10. M1 is considered as the most important measure of money ( )
11. M1 is considered as the most important measure of money ( )
12. When the price level increases, the value of money also increases ( )
13. Public expenditure comes under the monetary policy ( )
V. Matching
1. Liquidity preference () A. public debt
2. M3 () B. loss of barrowers
3. M2 () C. credit money
4. Fiscal policy () D. Highest moniners
5. Deflation () E. m2 + time deposit
6. Demand deposit () F. Bimetalism
7. Commercial banks () G. Keynes
8. Near money () H. Cheque
9. Grephsm law () I. Higher profity
10. Inflation () J. m1+ post office saving
VI. Give the answer in one or two sentences

1. Gresham’s law
Ans: The Law states that bad money drives good money out of circulation. This is true is case
of bimetallism where two metal standard (gold and silver) operate side by side. In such a case
one metal currency drives the other out of circulation. It also means cheap money drives out
dear money. If a country uses both money as well as mental money, People will use the paper
and hold the metal money.
2. Liquidity preference
Ans: Liquidity means the feature of the thing which can be exchanged in to others. Money
has more liquidity when compared to all other assets. So people prefer the money to keep it
as cash. It is called liquidity preference. The concept of liquidity preference was introduced by
J.M Keynes. According to him money is demanded for only liquidity preference.
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3. Repo Rate
Ans: When the RBI lends the money to the commercial banks on the basis of securities, it
charges some remuneration from the commercial banks, it is called Repo Rate. It is related to
short period only.
4. Deflation
Ans: If the prices are decreasing continuously, it is said to be deflation. In the period of
deflation almost all economic activities are down trend. But unemployment increases more
and more.
5. Stagflation
Ans: During the inflationary tendencies the price level increases but unemployment
decreases. During the deflation situation price level decreases but unemployment increases.
But price level increases and simultaneously unemployment also increases, this situation is
called stagflation.
6. Internal value of money

Ans: How much goods and services can be obtained in exchange of a unit or money
domestically is called internal external value.
7. External value of money

Ans: How much foreign currency can be obtained in the exchange of a unit of domestic
currency is called external exchange value.
8. Semi inflation
Ans: True inflation is formed after the full employment situation; semi inflation is formed
before reaching the full employment. There may be inflationary price rise in some sectors of
the economy.
9. Open inflation
Ans: When the government does not control the prices through administrative measures and
leave it to the market forces such type of inflation is called open inflation.
10. Deficit finance

Ans: When the government makes the borrowings from the RBI or issue the new currency to
fill the gap of the budget deficit, it is said to be deficit finance.
Answers:
II. Choose the Correct Answers
1. D 2. B 3. B 4. C 5. C 6. A 7. D 8. C 9. A 10. A
III. Fill in the Blanks

1. General Acceptability. 2. Near 3. Money 4. Precautionary
5. Standard of Deferred Payment. 6. Value of Money 7. Transaction
8. Demand Pull 9. Deflation 10. Store of Value
IV. True of False.

1. True 2. True 3. False 4. True 5. False
6. False 7. True 8. False 9. True 10. True
V. Match the following:

1. G 2. E 3. J 4. A 5. B 6. D 7. C 8. H 9. F 10. I
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STUDY NOTE 6
BANK
1. What is commercial Bank? And explain the function of commercial banks?

Ans: Bank
A commercial bank is a financial intermediary. It accepts the deposits from the surplus
units and lends these financial resources to the deficit units. The main aim of the commercial
banking sector is profit making.
Functions of commercial banks:

A bank is a financial institution. It is a profit-making business firm dealing with money.
Modern banks in India are joint stock companies registered under the Indian Companies Act.
Definition of Bank:
Sayers define bank as, “an institution whose debts (bank deposits) are widely accepted in
settlement of other people’s debts”.
According to Crowther, a bank “collects money from those who have it to spare or who
are saving it out of their incomes and lends this money to those who require it”.
Commercial Banks play a very prominent role in the financial system of an economy. They
perform a variety of functions as discussed below:
1. Acceptance of deposits:
One of the primary functions of a commercial bank is to accept deposits from the public.
The deposits accepted by the banks are of the following types.
(a) Current deposits:
These are the deposits made into the current account of a bank. They are most
convenient to the businessmen, public authorities and joint stock companies because there
are no restrictions on the number and the amount of withdrawals.
(b) Savings deposits:
These deposits are made into a savings bank account of the bank. They are most
convenient to the small businessman, salaried employees, artisans and people belonging to
the low and middle income groups. The interest paid on these deposits is comparatively low
and is around 4% per annum.
(c) Term deposits:
They are also called fixed deposits because the money is deposited with the bank for a
fixed period of time. The deposit can be withdrawn after the expiry of maturity period. The
minimum period of deposit is 15 days. The rate of interest varies from 6% per annum to 12%
per annum.
(d) Recurring or cumulative deposits:
These are the variants of fixed deposits. These deposits are very convenient to those who
cannot save huge amounts at a time. These deposits carry interest at a rate more than that of
savings bank and less than that of a term deposit.
2. Payment of loans and advances:

Another primary function if the commercial bank is to give loans and advances to different
section of the public like traders, industrialists, farmers, artisans etc.
(a) Demand loans/call loans:

A demand loan is a loan that should be repaid on demand by the bank. It does not have a
specified maturity period. This loan is a kind of advance made with or without security. These
are also called call loans. Normally call loans are given to other banks or financial institutions
for a day or a few days.
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(b) Short term loans:
These loans are given for a specified short period. They are sanctioned to businessmen
and farmers etc. to finance working capital. Individuals may also receive such loans as
personal loans. They are given against security.
(c) Cash credits:
A cash credit refers to an arrangement by which the bank allows its customer to borrow
money upto a specified limit from an account opened for the purpose. The customer need not
withdraw the entire amount in one installment.
(d) Overdraft:
This is a facility allowed by the bank to the current account holders. They are allowed to
withdraw money with or without security in excess of the balance available in their account
up to a limit. Interest is charged on the amount of actual withdrawal.
(e) Discounting the bills of exchange:
Bills of exchange are undertakings written by the buyers and given to sellers when the
transaction is made on credit basis. The buyer undertakes to make payment after a specified
period or on a specified future date. The traders who posses such bills of exchange with them
may approach the banks for discounting of the bills of exchange when they need money.
(d) Credit cards:
Now-a-days, the banks have devised new methods of giving loans to the customers. One
such popular method is issuance of the credit card. A credit cardholder can use his card to
purchase goods on credit from specified firms and shops and also withdraw cash subjects to
certain regulations.
3. Creation of Credit:
The commercial banks create credit. This is a unique function of commercial banks. Credit
is created from out of the primary deposits of money the customers, received from the public.
Part of the total amount of these deposits is given as loans and advances to its customers.
4. Agency Functions:
Commercial banks perform certain agency functions also:
(a) Collection of cheques, drafts, bills of exchange etc. of their customers from other
banks.
(b) Collection of dividends and interest from business and industrial firms.
(c) Purchase and sale of securities, shares, debentures, government securities on behalf of
the customers.
(d) Acting as trustees and keeping their funds in safe custody, acting as executors and
executing the will of the customers after their death.
(e) Making payments such as insurance premium, income-tax, subscriptions etc. on behalf
of their customers as per their advice.
5. General Utility Functions:

Besides the above agency functions, the commercial banks provide certain general utility
services to their customers.
(a) Provide locker facility for the safe custody of the silver, gold ornaments, important and
valuable documents.
(b) Transfer money of the customers from one bank to the other by way of demand drafts,
mail transfer.
(c) With the use of computers and internet facility, now-a-days the banks are facilitating
on-line transfer of money from one bank to the other.
(d) Issue letters of credit to enable the customers to purchase commodities on the basis of
credit.
(e) Endorse and provide guarantee to the shares issued by the joint stock companies and
help them in rising capital.
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(f) Traveler’s cheques are issued by the commercial banks to avoid the risk of carrying of
cash.
(g) Provide foreign exchange to the customers for exports and imports in connection with
the business.
(h) Convey information on behalf of their customers to the businessmen operating in
other places and also collect information of such businessmen and provide it to the
customers.
(i) Recently the commercial banks have been establishing ATMs (Automated Teller
Machines) at different locations so as to enable their customers to withdraw cash from their
accounts at any ATM at any time in a day.
2. What are the principles of commercial banks?

Ans: Principles of Commercial Banks:
1. Principles of liquidity:
Deposits are repayable on demand or after expiry of a certain period. Everyday depositors
either deposit or withdraw cash. To meet the demand for cash, all commercial banks have to
keep certain amount of cash in their custody.
2. Principles of profitability:
The driving force of commercial enterprise it sot generate profit. So it is true in case of
commercial bank also.
3. Principles of Solvency:
Commercial bank should have financially sound and maintain a required capital for
running the business.
4. Principles of safety:
While investing the fund, banks are to be cautions because bank’s money is depositor’s
money.
5. Principles of collection of savings:
This is a very important principle for today’s banking business. Commercial banks always
seek huge amount of idle money from the clients. Now a day’s banks fix up the target for their
employees to generate more savings from the people.
6. Principles of loan and investment policy:
The main earning sources of commercial banks are lending and investing money to the
viable projects. So commercial banks always try to earn profit through sound investment.
7. Principles of economy:
Commercial banks never go for any unnecessary expenditure. They always try to maintain
their functions with economy that increase their yearly profit.
8. Principles of providing services:
A better service brings great reputation for the bank.
9. Principles of secrecy:
Commercial bank maintains and keeps the clients accounts secretly. Nobody except the
legitimized person is allowed to see the accounts of the clients.
10. Principles of modernization:
It is the age of science and technology. So to cope up with the advanced world the
commercial bank has to adopt modern technical services like online banking, credit card etc.
11. Principles of specialization:
It is an age of specialization. Here commercial banks segments their whole functions into
various parts and place their human resources according to their efficiency.
12. Principles of location:
Commercial banks choose a suitable site where the availability of customers is large.
13. Principles of relation:
Commercial banks always try to maintain a good relation with their clients and potential
customers.
14. Principles of publicity:
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It is an age of publicity. If you would like to earn more money, you have to give more
advertisement through various media. In that case, commercial banks follow this kind of
principles to increase their customers.
3. What are essential conditions of sound banking system?

Ans: Essentials of a sound Banking System:
A sound banking system promotes all round economic development of an economy. A
good bank must have the following features:-
(a) Adequate Liquidity –
A bank must keep sufficient cash in hand to meet the claim of depositors, otherwise they
would be insolvent. A bank failure not only affects depositors but banks also. People would
not more keep funds with banker. It ensures safety of a bank. Unless a bank is safe it cannot
render its social services.
(b) Expansion of banking-
Banking facilities should spread throughout the economy. It must also cover all sections of
people in need of funds and all productive activities. The less-developed regions should get
more banking facilities than others. Thus, diffusion of banking offices is essential.
(c) Investment and loan policies –
A sound banking system must have a sound investment policy whereby it can optimize the
twin goals of liquidity and profitability. If loan and investments are wrong, a bank suffers loss
or face liquidity shortage. A prudent banker should carefully determine the composition and
character of its loans and advances so as to optimize earning without endangering safety and
solvency.
(d) Human factor –
The soundness of a bank depends much on the quality of banker. Banking being a
practical affair, rigid application of bank laws are not always fruitful. Much depends on the
discretion of men piloting the ship. Sound banking thus, depends more on banking personnel
than on banking laws.
4. What is meant by credit creation? And state the limitations of credit creation?
Ans: Credit Creation by Commercial bank:
• A commercial bank is called a dealer or credit.
• It can create credit i.e. can expand the monetary base of a country.
• It does so not by issuing new money but by its loan operations.
• Banks create money on the basis of the cash deposits.
• The process of credit creation is that the depositors think they have so much money
with banks and borrowers from bank say they have so much money with them.
• Summing the two, we find an amount more than the cash deposit.
• Suppose a bank receive a sum of ` 1,000 as deposit, keeps with it 20% (` 200) as CRR
(cash reserve ratio) and lends and rest.
• Depositor will claim he has ` 1,000 and bank borrower too possesses ` 800.
• Thus total money supply appears to be ` 1,800 only. It is the credit creation by a single
bank.
• The above example can be extended to cover the banking system as whole. Suppose `
800 is deposited to another bank.
• This bank’s base will now expand. It will keep 20% of ` 800 (` 160) as cash reserve and
will lend ` 640.
• This sum is redeposited to a third bank which keeps 20% of ` 640 (` 128) and grants a
loan of ` 512.
• This process will continue and the mount of fresh deposit will go on falling
• A time will come when deposited sum will be equal to CRR.
• The process will then come to an end.
Limitations of Credit Creation:
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Size of the cash reserve ratio:
Much depends on the six of the cash reserve ratio. Credit creation is inversely related to
CRR.
Amount of loan given:
Credit creation depends upon the amount of loan given. If borrowers cannot offer security
against loan, bank cannot lend.
Size of the cash deposit:

Size of the cash deposit is also important in this context. The smaller the cash base the
smaller scope a bank gets for credit creation. If people prefer physical assets or prefer to keep
cash in their hand, bank deposits suffer much, so bank cannot lend much.
Acceptable securities:
A bank can lend money against acceptable securities. A borrower gets a loan from a bank
only against come securities the value of which must be equal to the amount of the loan.
5. What are the functions of central bank?

Ans: Central Bank is the apex of the banking system in a country. It controls, regulates and
supervises the activities of the banks and the country’s banking system.
In our country the Central Bank was established in 1935 under private management. It
was nationalized by the Government in 1949 and named as RBI.
Objectives of the Central Bank:

The Central Bank functions with the objectives given below:
1. To maintain the internal value of currency.
2. To preserve the external value of currency.
3. To ensure price stability.
4. To promote financial institutions.
5. To promote economic development.
Functions of a Central Bank:

A Central Bank has the following functions:
1. Note Issue:
The Central Bank alone is authorized to issue the currency notes in a country. It has the
monopoly of note issue as no other bank is permitted to do so. It also enables the Central
Bank to control the supply of money as per the requirements of the economy.
2. Banker to Government:
The Central Bank acts as a banker, agent and financial advisor to government in the
following ways:
(a) It maintains the accounts of the government funds.
(b) It receives money and makes payments on behalf of the government.
(c) It gives ‘ways and means’ advances to the government.
(d) It issues new loans on behalf of the government.
(e) It manages the public debt.
(f) It undertakes foreign exchange transactions on behalf of the government.
(g) It acts as the agent of the government in dealing with the international financial
institutions like IMF and World Bank.
(h) It advises the Government on all financial matters.
3. Banker’s Bank:
The Central bank acts as a banker’s bank in the following manner.
(a) Every bank maintains a certain minimum of cash reserves with the Central Bank as a
statutory obligation.
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(b) It serves as a lender of last resort. This helps the commercial banks to overcome the
problems of liquidity and will be able to meet the demand for withdrawals even in times of
financial stringency.
(c) It acts as a clearing house for the commercial banks to settle their inter-bank accounts.
This is possible because all commercial banks have account with the Central Bank in which the
Central Bank keeps their cash balances.
4. Lender of last resort:

The Central Bank serves a lender of last resort not only to commercial banks but also to
discount houses, and other credit institutions. They may approach the central bank when they
face the problem of liquidity.
5. Controller of credit:
This is the most important function of the Central Bank. It controls the volume of credit in
the economy through appropriate monetary policy. It takes steps to reduce the credit in case
of inflation.
6. Custodian of foreign exchange reserves:

The Central bank maintains the reserves of foreign exchange and regulates their use. It
has the responsibility to maintain the stability of the exchange rate of the native currency in
terms of the foreign currency.
6. What are the instruments used by RBI to control the credit creation?
Ans: Credit Control by Central Bank
• A central bank possesses a number of instruments for controlling credit money.
• These are of two types – Quantitative and Qualitative.
• Quantitative techniques seek to regulate total quantity of credit while qualitative
measures affect the availability of credit.
I. Instruments of Qualitative Measures:

A) Bank Rate Policy:
• As a banker’s bank, a central bank lends money or rediscounts the bills of commercial
banks.
• The rate of interest charged by the central bank is known as Bank rate or Discount rate.
• By manipulating bank rate central bank can regulate the credit creating power of
member banks.
• If bank rate is raised by the central bank, commercial banks are to borrow at a higher
cost.
• Then the y will increase their lending rate. This rate is known as the market rate.
• The difference between market rate and bank rate is the profit margin of commercial
banks.
• When bank rate rises market rate also rises and vice versa.
• Demand for bank loan will reduce.
• On the other hand, for credit expansion, bank rate is reduced.
• The effectiveness of this technique depends on the extent to which commercial banks
depend on central bank for loan and rediscounting.
• If banks can collect funds from other sources at relatively cheaper rate, they need not
depend on central bank credit.
• Again if investment opportunities are not present, the market demand for credit will
weak, a fall in the bank rate may not raise the level of bank credit.
B) Open Market Operations:

• It implies purchase and sale of securities in the stock market.
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• When the central bank appears in the market as a seller of government securities,
people buy such securities by withdrawing money from banks or the banks themselves
invest in such securities instead of granting loan to public.
• In either case the powers of creating credit will be restricted.
• On the other hand, if central bank buys securities money flows out thus enlarging the
cash base of members banks.
• Credit expansion depends upon external business environment and borrowers
attitudes over which banks have no influence.
C) Variation or Reserve ratio:

• Commercial banks are legally bound to keep a portion of their deposits in the form of
cash reserve.
• It is the most liquid asset in their hand and at the same time it is zero earning assets.
• Naturally by altering the CRR, the central bank can expand or reduce the funds bank
can lend.
• There exists an inverse relation between the size of cash reserve and the amount of
credit given by a bank, assuming a given amount of deposit.
• In under developed money market this technique is more suitable than open market
operation or bank rate policy.
II. Qualitative Credit controls:

• A central bank also possesses certain techniques by which it can control the direction
and distribution of credit – purpose wise or areas wise.
• The purpose of selective controls is the rational allocation of scarce bank credit and its
economic utilization.
• Further sectorial development of credit and controlling in other directions serve the
purpose of preventing speculative activities with the help of bank finance and favoring
productive activities.
• These techniques are very helpful in a less-developed economy where overall credit
restriction may hinder growth by preventing the flow of credit for investment.
Moral Suasion:
• Moral suasion is a qualitative technique.
• The central bank ‘requests’ banks to lend more or not to lend in some sectors.
• There is no legal compulsion behind their acceptance.
• Generally if a request is not carried out by the number bank, the guardian of the
banking system may take such steps as banks are forced to accept.
• The central bank is often empowered to issue directives to member banks.
• Such direct orders are in the form of directional control, prohibiting loans of particular
type of giving advice to grant loan to priority sectors.
7. Distinction between Central Bank and commercial banks?

Ans: Distinction between the Central Bank and the Commercial Bank –
Basis of distinction Central banks Commercial banks
Monetary Authority Enjoys supreme monetary No authority, hence no such power
authority with wide powers is enjoyed.
Profit motive It does not exist to make profits of It exists and is organized for profits
its for owners their owners
Money supply to the It is the ultimate source of money No such function is performed by it.
economy supply to the economy.
Services rendered It acts as a banker to the It acts as a banker to private
government industrial and institutions
Chance of failure It is the lender of last resort and It often undertakes risky business
hence never fails activities and sometimes may fail.
Service to the public It neither does accept deposits Accepting deposits and lending
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from public, nor lends money to money to the public are the most
the public. important functions of commercial
banks.
Ownership and It is generally subordinate to the It is mostly privately owned and
managing Authority state, i.e. state owned and state privately managed.
managed.
Nature of operation It issues paper notes in fact it Its nature operation is credit
enjoys the monopoly power in this creation and cannot issue paper
matter notes.
Basis of operation The basis of cash money issued is The basis of credit money generated
gold and foreign reserve. is cash deposit.
8. Different kinds of Financial Institutions.

Ans:
1. Industrial finance corporation of India (IFCI) – 1948
It was established in 1st July 1948 the main object of IFCI is to make medium and long term
credit to the industrial units.
Functions:-
1. Granting loans and advances for the period of 25 years.
2. Subscribing to the shares and debentures floated by industrials concerns.
3. Granting loans in foreign currencies.
4. Guaranteeing for differed payments in respect of import of capital goods.
2. State Financial corporation (SFC) – 1953

The Government of India passed the State Financial Corporation Act in 1951 and made it
applicable to the states.
Functions:
(i)To guarantee loans raised by industrial concerns which are repayable within a period not
exceeding 20 years and which are floated in the public market.
(ii)Ito underwrite the issue of stocks, shares, bonds or debentures of industrial concerns.
(iii)To grant loans and advances to industrial concerns repayable within a period not exceeding
20 years.
Besides SFC’s there are 28 state Industrial Development Corporations which promote industrial
development in their respective states.
3. Industrial credit and investment corporation of India (ICICI) – 1955

It played facilitating role in consolidation in various sectors of the Indian Industry, by
financing, mergers and acquisition.
Functions:
(i)It offered long-term and medium-term loans, both rupee loans and foreign currency loan.
(ii)Participated in equity capital and in debentures and underwrote new issues of shares and
debentures.
(iii)Guaranteed loans from other private government sources.
(iv)Provided financial services such as deferred credit, leasing credit, installment sale, asset
credit and venture capital
Loans disbursed by ICICI increased from Rs. 180 crores in 1981 to Rs. 31, 660 in 2001.
4. State Industrial Development cooperation (SIDC) – 1960

The main object for the establishment of SIDC is to achieve the rapid industrialization in the
state at present there are 28 SIDC’s in India.
5. Unit trust of India (UTI) – 1964

It was established in 1st February 1964. The main object of the UTI is to encourage and
mobilized the savings of the community and canalized them into productive corporate
investment.
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Function of UTI:
1. Mobilized the saving of the relatively small investors.
2. Channelized these small savings into productive investments.
3. Distribute the large scale economies among small income groups.
6. Industrial Development Bank of India (IDBI)-1964:
The Industrial Develop Bank of India was set up in July 1964, to provide long term finance to
industry. In February 1976 the IDBI was made an autonomous institution.
Functions:
(i)The IDBI provided direct financial assistance to industries in the form of loans,
underwriting s and direct subscription to shares, debentures and guarantees.
(ii)It provides indirect financial assistance to industries by providing finance to State Financial
Corporations, State Industrial Development Corporations and Commercial Banks.
(iii)The IDBI initiated certain financial and non-financial measures to encourage industries in
backward areas.
(iv)It provides training in project evaluation and development of entrepreneurship.
(v)It also operated a Technical Consultancy Organization (TCO) to undertake feasibility
status, project appraisals, industrial and market potential surveys.
IDBI provides training to new entrepreneurs.
7. Export and Import Bank of India (EXIM bank)- 1982:

It was established in 1st March 1982. It is a non-bank financial intermediary (NBFI) confined its
area of operations to foreign trade of India. It also performs other functions.
1. Export rediscounting
2. Re-finance supply credit
3. Bulk import finance
4. Foreign currency pre-shipment credit.
5. Product equipment finance programme.
6. Business advisory technical assistance (BATA)
8. National Bank Agriculture and Rural Development (NABARD)-1982

It was established in July 1982 on the basis of the recommendations’ of CRAFI CARD.
1. It is the apex body in the agricultural credit
2. It taking over the functions of agriculture credit department of RBI and Agriculture re-
finance development corporation (ARDC).
3. It provides all sources of refinance to the cooperatives, commercial banks and regional
rural banks
(RRB)
It also promoting the research in agriculture and rural development.
9. Life Insurance corporation of India (LIC) – 1956

It was established in 1956 by nationalizing 245 private insurance companies. The primary
object of nationalization was to protect the interest of the policy holders and avoid the misuse
of funds secondly, the object of nationalization was to direct the investments of funds in
government security (87.5%), leaving a small part for private sector (12.5%).
10. General insurance company (GIC)-1972

It was formed as Government Company in 1972. Before nationalization a few big companies
and about 100 small companies were in this business. At present GIC is provided by 4
companies they are
(i) National Insurance Company (NIC)
(ii) New India Assurance company (NIAC)
(iii) Oriental fire and general insurance company
(iv) United India fire and general insurance company
The main feature of GIC is to sell insurance services against some forms of risk like loss of
physical assets of various kinds i.e. the fire accident, and against personal sickness and
accidents.
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11. Securities and Exchange Board of India (SEBI) – 1988
It was setup in 1988. It got statuary reorganization in 1992. The main purpose of the SEBI is
regulating business in stock markets & other securities market.
12. Asian Development Bank (ADB) – 1966
1. It was established in 1966
2. The main aim for the establishment of ADB is to promote the socio and economic
progress of number countries in Asia & pacific.
3. It is owned by governments of 37 countries form region and 16 countries from outside
the region.
4. Its head quarters is manila, Philippines
5. Poverty reduction is now the main mission of DAB
13. International Monetary Fund (IMF) – 1947

It was established in March 1947 one of the outcomes of Breton wood conference was IMF.
The main object of IMF is to administer a code of fair practice in the sphere of foreign
exchange and to make loans to the economies experiencing temporary deficit in their balance
of payments.
Quota:
It is the membership contribution fixed in terms of its national income and internal trade
members are required to subscribe quota partly in gold (25%) party in domestic currency
(75%).
Exchange rate:
Members of IMF had to declare the par value of national currency in terms of gold or
American dollars.
Once the par value of different currencies is fixed it becomes easy to determine the rate of
exchange between two countries.
Special Drawing Rights (SDRs) – 1969:
SDR’s was first introduced in 1969. It is the special currency issued by IMF. For two reasons
IMF created SDR. They are
1. To overcome the shortage of gold in the world economy
2. To avoid the movement of gold across national boundaries.
SDRs are in Coupons:
It is used in the place of gold. Hence it is called paper gold.
14. World Bank:

It was established in 1947 one of the outcomes of Breton wood conference was establish of
World Bank. The main aim of the establishment of World Bank is to help re-construction of
the member countries damages due to the Second World War. The original name of World
Bank is international bank for reconstruction and development (IBRD).
15. International development Association (IDA)

It was established in 1960 and it is affiliated to World Bank. The main aim for the
establishment of IDA is to provide assistance to low developed countries (LDC) whose per –
capita income in less than (dollar) $ 520 (1975). It also grants the credit on cheap terms
compared to World Bank loans.
I. List of questions:
1. What is commercial Bank? And explain the function of commercial banks?
2. What are the principles of commercial banks?
3. What are essential conditions of sound banking system?
4. What is meant by credit creation? And state the limitations of credit creation?
5. What are the functions of central bank?
6. What are the instruments used by RBI to control the credit creation?
7. Distinction between Central Bank and commercial banks?
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8. Explain about IFCI (expansion)
9. Explain about IDBI
10. Explain about SFC
11. Explain about EXIM Bank
12. Explain about NABARD
13. Explain about ADB
14. Explain about IMF
15. Explain about SEBI

1. Which is the apex bank for agricultural credit in India?
(a) RBI (b) SIDBI (c) NABARD (d) IDBI
2. RBI check inflation by
(a) Increasing bank rate (b) Increasing CRR (c) Both (d) None
3. If the country is passing through recession, the RBI would
(a) Buy bonds (b) Reduce CRR
(c) Ease out bank rate (d) All or any of the above three
4. Manipulation in CRR enables the RBI to
(a) Influence the lending ability of the commercial banks
(b) Check unemployment growth (c) Check poverty (d) Increase GDP
5. EXIM Bank is authorized to raise loan from
(a) RBI (b) Government of India (c) International market (d) Trading activities
6. RBI was nationalized in
(a) June 1947 (b) Jan 1949 (c) March 1954 (d) April 1936
7. FERA has been replaced by
(a) FINA (b) FEMA (c) FENA (d) MRTP
8. Repo transaction means
(a) Sale of securities by the bolder to the investor with the agreement to purchase them
at a predetermined rate and date.
(b) Sale of securities by the holder to the investor with the agreement to resell them at a
predetermined rate and date.
(c) Sale and purchase of securities by the holder to the investor with the agreement to
purchase them at the prevailing rate and date
(d) Sale of securities by the holder to the investor with the agreement to purchase them
at market driven rate.
9. Reverse Repo transaction means
(a) Sale of securities by the holder to the investor with the agreement to purchase them
at a predetermined rate and date
(b) Sale or purchase of securities by the holder to the investor with the commitment to
sell or purchase them at a predetermined rate and date
purchase them at the prevailing rate and date
(d) Sale of securities by the holder to the investor with the agreement to purchase them
at market driven rate
10. Given a reserve ratio of 20% in initial deposit of `1000 in a banking system would create
secondary deposit of
(a) ` 3,000 (b) ` 5,000 (c) ` 4,000 (d) ` 6,000
11. Which one of the following functions of commercial banks include collection of cheques,
drafts, bill of exchange etc. of their customers from other banks?
(a) Agency Function (b) Creation of Credit (c) Payment of Loans & Advances
(d) General Utility Function
12. The rate at which the commercial banks borrow from the Reserve Bank Of India is called as
(a) REPO (b) PLR (c) BPLR (d) Bank rate
13. SDRs are used in place of ________________
(a) Commercial papers (b) Gold (c) Shares (d) Company deposits
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14. __________ is one among the qualitative credit control instruments used by the RBI
(a) Bank Rate Policy (b) Moral Suasion
(c) Open Market Operations (d) Cash Reserve Ratio
15. Traditional function of a commercial bank is __________

(a) Issue of gift Cheque (b) Credit creation
(c) Providing locker facilities (d) Acceptance of deposits
16. ___________ is one among the quantitative methods of credit control.
(a) Bank Rate Policy (b) Moral Suasion (c) Direct Action (d) Rationing
of Credit
17. Securities market in India is regulated by the _______________
(a) Government (b) RBI (c) SEBI (d) SBI
18. _____________ Account can be opened by business persons only.
(a) Current Deposit (b) Savings Deposit (c) Fixed Deposit (d) Recurring
Deposit
19. In India, Central Bank was established in _________
(a) 1945 (b) 1955 (c) 1935 (d) 1965
20. ___________ is a qualitative credit control instrument used by the Central Bank.
(a) Bank Rate Policy (b) Moral Suasion (c) Open Market Operations (d) CCR
21. __________ was established as the apex bank for industrial credit.
(a) IDBI (b) ICICI (c) EXIM Bank (d) NABARD
22. Select the quantitative credit control method from the following alternatives:
(a) Moral suasion (b) Open market operations
(c) Rationing of credit (d) Licensing of branches
23. The credit instruments are issued on the basis of –
(a) Capital Reserve (b) Cash Reserve
(c) General Reserve (d) Capital redemption reserve
24. Which of the following is not a method, by which banks create funds?
(a) Share capital (b) Reserve funds (c) Borrowing from general public (d) Investments
25. Who is the custodian of national reserves of international currency?
(a) SBI (b) IDBI (c) RBI (d) ICICI
26. With the increase in the banking habits of the people the value of deposit multiplier –
(a) Decrease (b) Increase (c) Remain Constant (d) None of the above
State the sentence True or False

1. Bank is said to be dealer in debt ( )
2. Bank impose a limit on the amount and number of withdrawals on saving bank a/c ( )
3. Fixed deposits are followed by business people ( )
4. Over draft facility is given to small income people ( )
5. Banks keep the wills of their customers and execute them after their death ( )
6. CRR cannot control the credit creation ( )
7. RBI issues the one rupee notes and coming ( )
8. Moral situation is a qualitative technique ( )
9. Profit is the main motto of central Bank ( )
10. IMF secure the stability of foreign exchange rate ( )
11. Saving deposit is a demand deposit ( )
12. In India, the Central Bank was nationalized by the Government in 1949 ( )
13. Fixed deposit is a time deposit ( )
14. Credit creation is inversely related to CRR ( )
15. CRR cannot control the credit creation ( )
16. Profit is the main motto of central bank ( )
17. Fixed deposits are followed by business people ( )
V. Matching
1. Commercial Bank () A. Lender of last resort
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2. Credit creation () B. Exim bank
3. Central Bank () C. 1982
4. UTI () D. manila
5. Foreign trade () E. ARDC
6. ADB () F. 1969
7. SDR () G. commercial bank
8. LIC () I. Discounting bills
9. NABARD () J. Small investment
10. EXIM Bank () H. 1956
V. Give answer in one or two sentences.

1. Monetary policy
Ans: The Policy which is prepared by the RBI and implemented by the RBI to control the
money supply is called Monetary Policy. This is in two types 1. Expansionary Credit Policy 2.
Concretionary Credit Policy
2. Fiscal policy
Ans: The policy which is prepared by the government and implemented by the government to
control the purchasing power of money is called Fiscal policy. Any measurement which is
related to public revenue (tax policy), public expenditure and public debt is come under Fiscal
policy.
3. ICICI
Ans: It was established in 1955 the main aim of the ICICI is to develop the industries under the
private sectors only. It is a private bank. It also provide the loans in foreign currency and also
develop the under writing facilities.
4. SIDC
Ans: The main object for the establishment of SIDC is to achieve the rapid industrialization in
the state. At present there are 28 SIDC’s in India. These intuitions are providing assistance to
entrepreneurs and those industrial under takings that are set up in back ward regions.
5. L.I.C
Ans: It was established in 1956 by nationalizing 245 private insurance companies. The primary
object of nationalization was to protect the interest of the policy holders and avoid the misuse
of funds secondly, the object of nationalization was to direct the investments of funds in
government security (87.5%), leaving a small part for private sector (12.5%).
6. G.I.C
Ans:It was formed as Government Company in 1972 before nationalization a few big
companies and about 100 small companies were in this business. At present GIC is provided 4
companies they are
(i) National Insurance Company (NIC)
(ii) New India Assurance company (NIAC)
(iii) Oriental fire and general insurance company
(iv) United India fire and general insurance company
The main feature of GIC is to sell insurance services against some forms of risk like loss of
physical assets of various kinds i.e. the fire accident, and against personal sickness and
accidents.
7. SDR
Ans: SDR’s was first introduced in 1969. It is the special currency issued by IMF. For two
reasons IFM created SDR. They are
(i) To overcome the shortage of gold in the world economy
(ii) To avoid the movement of gold across national boundaries
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SDRs are in Coupons: It is used in the place of gold. Hence it is called paper gold.
8. Quota
Ans: It is the membership contribution fixed in terms of its national income and internal trade
members are required to subscribe quota partly in gold (25%) party in domestic currency
(75%).
9. World bank
Ans: It was established in 1947 one of the outcome of Breton wood conference was establish
of World Bank. The main aim of the establishment of World Bank is to help re-construction of
the member countries damages due to the Second World War. The original name of World
Bank is international bank for reconstruction and development (IBRD).
10. Over draft

Ans: This is a facility allowed by the bank to the current account holders. They are allowed to
withdraw money with or without security in excess of the balance available in their account
up to a limit. Interest is charged on the amount of actual withdrawal.
Answers:
1. C 2. C 3. D 4. A 5. B 6. B 7. B 8. A 9. B 10. C
1. IDBI 2. RBI 3. Loan 4. Commercial 5. Idle
6. Note 7. Decreas 8. Private 9. NABARD 10. World
VI. True or False:
1. True 2. True 3. False 4. False 5. True
6. False 7. False 8. False 9. False 10. True
V. Matching:
1. I 2. G 3. A 4. J 5. B 6. D 7. F 8. H 9. E 10. C
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STUDY NOTE 8
MONEY MARKET
1. Define money market and state the objectives of money market?

Ans: Meaning of Money Market:
Financial markets are functionally classified into
(a) Money market and
(b) Capital market.
This classification is on the basis of the term of credit, i.e., whether the credit is supplied
for a short period or long period. Money market refers to institutional arrangements which
deal with short- term funds. Capital market, on the other hand deals in long-terms funds.
Money market is a short-term credit market which deals with relatively liquid and quickly
marketable assets such as, short-term government securities, treasury bills, bills of exchange,
etc.,
Definition:
1. According to Crowther, “The money market is a collective name given to the various firms
and institutions that deal with various grades of near- money”.
2. The Reserve Bank of India defines money market “as the center for dealing, mainly of a
short-term character, in monetary assets; it meets the short-term requirements of borrowers
and provides liquidity of cash to the lenders.
Objectives of Money Market:

A well-developed money market serves the following objectives:
(i) Provides an equilibrium mechanism for ironing out short-term surplus and deficits.
(ii) Provides a focal point for the intervention of the central bank for influencing liquidity in
the economy.
(iii) Provides access to user of short term money to meet their requirements at a reasonable
price.
2. Define money market and state the characteristics of money market?
Ans: Characteristics of Money Marketing:

Indian money market has major features:
1. Short-term funds are borrowed and lent.
2. No fixed place for conduct of operations. Transactions are conducted even over the
phone.
3. Dealing may be conducted with or without the help of brokers.
4. The short-term financial assets that are dealt in are close substitutes for money.
5. Funds are loaned for a maximum period of 1 year.
6. Presence of a large number of sub-markets.
3. What is money market and explain the functions of money market?

Ans: Functions of Money Market:
1. It links lenders and borrowers of short-term funds. It is purely a market for short term
funds or financial assets.
2. It provides working capital requirements of industry, trade and agriculture.
3. It provides financial assets with high a degree of liquidity- call money, treasury bills,
commercial bills etc.
4. It helps trade and commerce by developing a bill market, and acceptance market.
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5. It enables the Government to raise short-term loans with Treasury bill market.
6. It is controlled and regulated by RBI.
7. It makes the monetary policy effective.
8. It provides opportunities for lending the surplus funds of individuals, banks and other
institutions.
9. It helps the central bank in maintaining stability of the value of the currency unit.
4. Explain the structure of money market.
Ans: Structure of Money Market: Structure of Indian Money Market
Organized Sector Unorganized Sector
Reserve Bank of Commercial Banks Saving Banks Non-Banking Cooperative

India companies Banks
Scheduled Commercial Banks Non-Scheduled Banks
Public sector Banks Indian Banks
State bank Group Nationalised Banks

Organized Sector:
It is called organized because its activities are systematically coordinated by the RBI Many
players are there in the organized sector. They are:
(i) The organized modern sector of Indian money market comprises:
(a) the Reserve Bank of India;
(b) the State Bank of India and its associate banks;
(c) the Indian joint stock commercial banks (Scheduled and non-scheduled) of which 27
scheduled banks have been nationalized
(d) the exchange banks which mainly finance Indian foreign trade;
(e) cooperative bank;
(f) other special institutions, such as, Industrial Development Bank of India, State Finance
Corporations, National Bank for Agriculture and Rural Development, Export-Import Bank,
etc., which operate in the money market indirectly through banks; and
(ii) Non-bank financial institutions such as the LIC, the GIC and subsidiaries, the UTI operate in
this market, but only indirectly through banks, and not directly.
(iii) Quasi-Government bodies and large companies also market their short-term surplus funds
available to the organized market through banks.
(iv) Co-operative credit institutions occupy the intermediary position between organized and
unorganized parts of the Indian money market. These institutions have a three tire
structure. At the top, there are State cooperative banks, At the local level, there are
primary credit societies and urban cooperative banks, Considering the size, methods of
operations, and dealings with RBI and commercial banks, only state and Central
cooperative banks should be included in the organized sector, The cooperative societies at
the local level are only loosely linked with it.
Unorganized Sector:
The unorganized sector consists of indigenous banks and money lenders. It is unorganized
because activities of its parts are not systematically coordinated by the RBI. The money
lenders operate throughout the country, but without any link among themselves indigenous
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banks are somewhat better organized because they enjoy rediscount facilities from the
commercial banks which, in turn, have link with the RBI. But this type of organization
represents only a loose link with the RBI.
5. What are the constituents of money market?

Ans: Constituents of Money market: Lenders & Borrowers
Money market is a center where short-term funds are supplied and demanded. Thus, the
main constituents of money market are the lenders who supply and the borrowers who
demand short-term credit.
1. Supply of Funds:
There are two main sources of supply of short-term ‘funds in the Indian money market: (a)
unorganized indigenous sector, and (b) organized modern sector.
2. Demand for Funds:

In the Indian money market, the main borrowers of short-term funds are : (a) Central
Government, (b) State Government, (c) Local bodies, such as municipalities, village
panchayats, etc., (d) traders, industrialists, farmers, exporters and importers, and (e) general
public.
6. What are instruments of Indian money market?

Ans: Sub- Markets of Organized Money Markets:
The organized sector of Indian money market can be further classified into the following
sub-markets. It has the following money market instruments:
Instrument of Indian Money Market
1. Commercial
Call money Bill Market: Treasury
Commercial Commercial Certificate Inter bank Collateral
These
and notice are Bills
bills of exchange dawn
Bills by the seller (drawer) on
Papers ofthe buyer (drawee
deposit and acceptor)
participation loan market
moneyfor the value of goods sold. When once the bill is accepted by the buyer ofcertificate
goods (drawee), it
becomes a legal document acknowledging indebtedness. It is a negotiable instrument. Such
bills are drawn generally for 90 days. During the tenure of the bill, if the bolder is in need of
cash he can discount it with a commercial bank. The bank will deduct interest (called a
negotiated discount rate) for the period the bill is yet to run. The bank will receive the face
value on the due date from the drawee. Meanwhile, if the bank is in need of funds, it can
rediscount it in the commercial bill rediscount market at the market-related discount rate.
Banks arrange their bill portfolio in such a manner that some bills mature every day. These
trade bills (commercial bills) are considered liquid assets as they can be converted in to cash
quickly by rediscounting.
2. Call and Notice Money Market:

The call and Notice Market constitutes the core of the Indian Money Market. Call money
represents the amount borrowed by commercial banks from each other for short periods to
meet their cash reserve requirements, Those banks whose cash reserves decline below the
statutory requirement borrow from such banks which have surplus cash reserves, Funds are
thus borrowed and lent for one day (call) and for a period up to 14 days (notice) without any
collateral security. The market has thus two segments- (I) call or overnight market and (ii)
short notice market. The rate at which funds are borrowed and bent in this market is called
call money rate. The rate is determined by demand and supply.
3. Treasury Bills Market:

Treasury bills are short-term promissory notes issued by the G.O.I at discount generally
for a period of 91 days. They are issued to meet short-term financial needs of the
Government. Since November 1986, 182 days Treasury Bills are issued by the R.B.I Longer
maturity Treasury Bills with varying maturities upto 364 days are introduced in April 1992.
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These bills are issued as a part of public debt operations of G.O.I. They are issued at discount
and therefore do not carry interest payment obligation.
4. Commercial Paper:
On the recommendations of Vaghul working Group, commercial paper is introduced in the
Indian money market in January 1990. The need for the introduction of this instrument has
arisen out of the changing industrial scenario. In the environment created by Liberalization
policies of the Government, the industrial sector launched plans of diversification, expansion
and modernization of their units. This has lead to an enhanced demand for funds and to
satisfy the demand C.P is introduced. Commercial papers are unsecured promissory notes
issued by corporate entries to raise resources for their short-term needs instead of borrowing
from banks. It is a certificate evidencing an unsecured corporate debt of short maturity. It
represents a promise by the borrowing company to repay loan at a specified date.
5. Certificate of Deposit:
The RBI introduced the Certificates of Deposits Scheme in June 1989. The object is to further
widen the range of money market instruments and to give investors further opportunity of
deploy their short-term funds. C.D’s are deposit receipts issued by banks against deposits kept
by individuals, companies, P.S.Us and other institutions. Non-resident Indian can also
subscribe to C.Ds but only on a non-repatriation basis.
7. Explain the defects of Indian money market.

Ans: Defects of Indian Money Market
The Indian money market is inadequately developed, loosely organized and suffers from
many weaknesses. Major defects are discussed below:-
1. Dichotomy between Organized and Unorganized Sectors:

The most important defect of the Indian money market is its division into two sectors: (a)
the organized sector and (b) the unorganized sector. There is little contract, coordination and
cooperation between the two sectors. In such conditions it is difficult for the Reserve Bank to
ensure uniform and effective implementations of its monetary policy in both the sectors.
2. Predominance of Unorganized Sector:

Another important defect of the Indian money market is its predominance of unorganized
sector. These indigenous bankers, which constitute a large portion of the money market,
remain outside the organized sector. Therefore, they seriously restrict the Reserve Bank’s
control over the money market.
3. Wasteful Competition:
Wasteful competition exists not only between the organized and unorganized sectors, but
also among the members of the two sectors. The relation between various segments of the
money market is not cordial; they are loosely connected with each other and generally follow
separatist tendencies. Similarly, competition exists between the Indian commercial banks and
foreign banks.
4. Absence of All- Indian Money Market:

Indian money market has not been organized in to a single integrated all-Indian market. It
is divided into small segments mostly catering to the local financial needs. For examples, there
is little contract between the money market in the bigger cities. Like, Mumbai, Chennai, and
Kolkata and those in smaller towns.
5. Inadequate Banking Facilities:

Indian money market is inadequate to meet the financial needs of the economy. Although
there has been rapid expansion of bank branches in recent years particularly after the
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nationalization of banks, yet vast rural areas still exist without banking facilities. As compared
to the size and population of the country, the banking institutions are not enough.
6. Shortage of capital:
Indian money market generally suffers from the shortage of capital funds. The availability
of capital in the money market is insufficient to meet the needs of industry and trade in the
county.
7. Seasonal Shortage of Funds:

A major drawback of the Indian money market is the seasonal stringency of credit and
higher interest rates during a part of the year. On the contrary, during the slack season, from
July to October, the demand for credit and the rate of interest decline sharply.
8. Diversity of Interest Rates:

Another defect of Indian money market is the multiplicity and disparity of interest rates.
The interest rates also differ in various centers like Mumbai, Kolkata etc. Variations in the
interest rate structure are largely due to the credit immobility because of inadequate, costly
and time-consuming means of transferring money. Disparities in the interest rates adversely
affect the smooth and effective functioning of the money market.
9. Absence of Bill Market:

The existence of a well- organized bill market is essential for the proper and efficient
working of money market. Unfortunately, in spite of the serious efforts made by the reserve
bank of India, the bill market in India has not yet been fully developed. The short-term bills
form a much smaller proportion of the bank finance in India as compared to that in the
advanced countries.
8. Explain the measures to improve the Indian money market.

Ans: Measures to Improve Indian money market:
In view of the various defects in the Indian money market, the following suggestions have
been made for its proper development:
(i) The activities of the indigenous banks should be brought under the effective control of the
Reserve Bank of India.
(ii) Hundies used in the money market should be standardized and written in the uniform
manner in order to develop an all-India money market.
(iii) Banking facilities should be expanded especially in the unbanked and neglected areas.
(iv) Discounting and rediscounting facilities should be expanded in a big way to develop the
bill market in the country.
(v) For raising the efficiency of the money market, the number of the clearing houses in the
country should be increased and their working improved.
(vi) Adequate and less costly remittance facilities should be provided to the businessmen to
increase the mobility of capital.
(vii) Variations in the interest rates should be reduced.
I. List of question:
1. Define money market and state the objectives of money market.
2. Define money market and state the capitalistic of money market.
3. What is money market and explain the functions of money market?
4. Explain the structure of money market.
5. What are the constituents of money market?
6. What are instruments of Indian money market?
7. Explain the defects of Indian money market?
8. Explain the measures to improve the Indian money market?
II. Choose the correct Answer
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1. Money market deals with the ………
(a) Short term credit (b) Long term credit (c) both A & B (d) None
2. Money market includes ………
(a) Government securities (b) treasury bill (c) bills of exchange (d) All the above
3. In Indian money market, who are the main borrowers of short term funds
(a) central government (b) State government (c) local bodies (d) All the above
4. Money market is controlled by …..
(a) Government (b) R.B.I (c) S.B.I (d) all the above
5. In April 1999 the government of India introduced the bills for the period of …..
(a) 91 days (b) 182 days (c) 364 days (d) None
6. In call money market funds are borrowed of rent without any security for the period of…
(a) one day (b) 14 days (c) a & b (d) None
7. If buyer of the goods is called ……
(a) Drawer (b) drawee (c) payee (d) none
8. Certificate of deposits are issued by the banks to …..
(a) individual (b) companies (c) P.S.U.S (d) All the above
9. Which are unsecured promissory notes
(a) Commercial paper (b) Certificate of deposits
(c) Treasury bills (d) all the above
10. Commercial banks provide collateral loans against …..
(a) bonds (b) govt. security (c) both A & B (d) None
11. On the basis of functions, financial markets are classified into ______________ types.
(a) 5 (b) 4 (c) 3 (d) 2
12. ___________ market is the nerve centre of the financial system
(a) Money (b) Capital (c) Local (d) National
13. Financial markets are classified into Money Market and ____________
(a) Bullion Market (b) Capital Market (c) Stock Market (d) National Market
14. Commercial Paper was introduced in Indian money market in January _____________
(a) 1990 (b) 1980 (c) 1970 (d) 1960
15. Generally Commercial bills are prepared for the period of _______________
(a) 90 (b) 180 (c) 360 (d) 365
16. Which are unsecured promissory notes
(a) Commercial paper (b) Certificate of deposits
(c) Treasury bills (d) All of the above
VI. True (or) false

1. The instrument commercial paper has risen out of the changing industrial scenario ( )
2. R.B.I introduced the certificates of deposits in June 1998 ( )
3. Collateral loans are given by commercial banks without security ( )
4. In Indian money market there is a multiplicity and disparity of interest rates ( )
5. The short term bills form a much smaller proportion of the bank finance in India as
compared to advanced countries ( )
6. Money market is controlled by RBI ( )
V. Matching:
Column A Column B
1. Corporate bank ( ) A. Money market
2. Commercial paper ( ) B. R.B.I
3. Seller ( ) C. Local bodies
4. Demand for money market ( ) D. Organized sector
5. Monetary policy ( ) E. Drawer.
VI. One sentence answer:

1. Commercial bill market
2. Call money market
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3. Treasury bills
4. Commercial paper.
5. Certificate of Deposit
Answers
I. Choose the correct answer:
1. (A) 2. (D) 3. (D) 4. (B) 5. (C) 6. (C) 7. (B) 8. (D) 9. (A) 10. (C)
II. Fill in the blanks:

1. Term of credit 2. Close substitute 3. Money market 4. Commercial Bank 5. 90
III. True (or) False

1. (T) 2. (F) 3. (F) 4. (T) 5. (T)
IV. Matching the following:

1. (D) 2. (A) 3. (E) 4. (C) 5. (B)
Fill in the blanks:
1. According to __________ Economics is the study of science of wealth.

2. According to _______ definition economic is a social science.
3. According to ______ top priority is given to man.
4. According to _______ Robbins Economics must be ___ between ends.
5. Alternative uses of limited resources leads to ______
6. According to ____ definition Economics is analytical science.
7. Growth definition is mostly associated with _____
8. ____ definition includes welfare definition and scarcity definition.
9. In deductive method the logic proceed from ___ to ____.
10. In inductive method the logic proceed form ____ to ____.
Fill in the blanks

1. According to law of demand, there is a __________ relationship between price and
demand.
2. If two or more than two goods are used to satisfy the same want are called ________.
3. In case of inferior goods, if the income rises than the demand _______.
4. Increase in demand due to the change in other things is called _____ in demand curve.
5. Total outlay method is also called _______.
6. Monopoly fixes the fewer prices if the demand is ______ elastic.
7. If there is no possibility to postpone the consumption of the commodity than the elasticity
is _____.
8. Supply curve in the case of labour is ______.
9. If the supply curve is parallel to ox-axis than the supply is _____
10. Perfectly elastic demand curve is ________
Fill in the blanks

1. Land is a ________ of nature
2. Land differ in __________.
3. Labour has ________ bargaining power.
4. Labour is _______ from labourer.
5. Capital supplies _____ and machinery.
6. _______ improve the productivity of labour.
7. Decision making is the function of ________ .
8. _______ pay the rewards to factors.
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9. Short period production function also called _______ .
10. Labour is _______ .
Fill in the blanks:

1. _________ curve never touch the ox-axis
2. Costs which do not involve any cash payment to outsides are called _______
3. Accounting costs equal to _______ costs.
4. _________ cost must be paid even if the firm’s level of output is zero.
5. When the total revenue equal to economic costs then the firm will earn ________
6. Tcn - Tcn-1 is equal to ______ cost
7. ATC curve will be in ________ shaped.
8. The vertical difference between TVC and TC is equal to _________ cost.
9. When the Ac=mc then the average cost is _______
10. Variable cost is also called _____
11. When the output is zero, the fixed cost is also zero
Fill in the blanks

1. According to Adam Smith invisible hands are also called ____
2. In _____ market the firm has excess production capacity in the long run
3. If the demand curve of pure monopoly is elastic, MR will be ___________
4. Average Revenue curve is also known as ________
5. Toilet soaps industry is an example of ____ market
6. Electricity supply service is an example of ______ market
7. Price rigidity is the feature of ______ market
8. In _____ market the firm has no definite demand curve
9. The demand for monopoly product is _________ elastic
10. The demand for monopolistic completion product is _____ elastic
Fill in the blanks

1. Money means any things that posses ___________
2. Bonds, Government securities refer to ________ money.
3. ______ Market is also called the credit market.
4. If someone keeps some money for bad days, the demand for money is known by _____
motive of money.
5. _____ function of money leads to saving and investment.
6. The inverse value of price is called _______
7. According to fisher theory money is demanded for _______ purpose
8. _____ Inflation rises due to mismatch between demand and supply of commodities.
9. When the prices are falling, it is said to be _______
10. According to Cambridge equation money is demanded for _______
Fill in the blanks:

1. SIDBI is a subsidiary bank of __________________
2. _____________ is the apex bank in banking system.
3. The two primary functions of a bank are deposit function and ______ function.
4. Credit creation is the function of _______ bank.
5. A bank must keep _____ cash in hand to meet the closing of depositors.
6. Central bank enjoys the exclusive power of _____ issue
7. If the bank rate increases, the demand for bank loan _____
8. ICICI is a ____________ sector bank
9. ARDC was merged in ________ bank
10. IDA is affiliated to _____bank.
Fill in the blanks

1. Financial market are classified into money market and capital market on the basis of ____
119
2. The short term financial assets that are dealt in are __________ for money
3. ________ provide working capital requirement s of industry, trade and agriculture.
4. Call money represent the amount borrowed by _______ from each other for the short
term requirement.
5. Generally commercial bills are prepared for the period of _____ days.

1.
Column – I Column - II
1 M3 (A) Demand forecasting
2 Collective Opinion Method (B) Price Maker
3 Collective Opinion Method (C) M2 + Time Deposit
4 Monopoly (D) Price taker
5 Perfect Competition (E) Control of Credit
2.
i Exceptions to the Law of Demand (A) K. E. Boulding
ii Oligopoly Market (B) Robert Giffen
iii Quantity Theory of Money (C) A.A. Cournot
iv Elasticity of Demand (D) Irving Fisher
v Micro-economics (E) Alfred Marshall
3
i Bad money drives good money out of (A) J.M. Keynes
circulation
ii Wealth of Nations (B) A.C. Pigou
iii Concept of Consumer Surplus (C) Gresham’s Law
iv Macro-economic Theory (D) Adam smith
v Increase in wealth means increase in welfare (E) Alfred Marshall
4.
i Definition of Scarcity (A) Giffen
ii Inferior Goods (B) Crowther
iii One who brings all the factors together and (C) Walker
produces the output
iv Money is what money does (D) Robbins
v Inflation denotes that Value of Money is falling (E) Entrepreneur
5.
i Acceptance of Deposit (A) Fixed Factor
ii Law of Demand (B) Monopoly
iii Land (C) Commercial Bank
iv Price Discrimination (D) Treasury Bills
v Money Market (E) Alfred Marshall
6.
Column – A Column - B
1 Commercial Banks A Duopoly
2 Deflation B Average cost
3 Two firms C Discounting Bills
4 Land D Loss of Borrowers
5 AFC + AVC E Fixed Factor
120
7.
1 Principles of Economics A Keynes
2 Banks B Marshall
3 Macro Economics C Movement of DD’ curve
4 Fiscal policy D Credit Creation
5 Contraction of demand E Public Debt
8.
1 Commercial Banks A Factor of production
2 Durable Goods B Average Cost
3 Labour C Acceptance of Deposits
4 Creation of Utility D Inelastic Demand
5 AFC + AVC E Production
9.
1 Land A Adam Smith
2 Central Bank B Fixed Factor
3 Wealth of Nation C Demand Curve
4 Fiscal Policy D Credit Control
5 Contraction of demand E Public Dept
10
1 Commercial Banks A Other things being constant
2 Durable Goods B Adam Smith
3 Ceteris Paribus C Acceptance of Deposits
4 Creation of Utility D Inelastic Demand
5 Father of Economics E Production
11.
1 Commercial paper A Adam smith
2 Central Bank B Money market
3 Wealth of Nation C Demand Curve
4 Fiscal policy D Credit Control
5 Contraction of demand E Public Debit
12.
1 Commercial Bank C Discounting Bills
2 Deflation D Loss of Borrowers
3 One firm A Monopoly
4 Land E Fixed Factor
5 AC – AVC B Average Fixed Cost
13.
1 Principles of Economics A Keynes
2 Central Bank B Marshall
3 Micro Economics C Movement of DD’ curve
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4 Price Discrimination D Credit Control
5 Contraction of demand E Monopoly
14.
Column – I Column - II
1 Proportional demand curve A Advertisements
2 Interdependence B Long period
3 Homogeneous product C Perfect market
4 Selling costs D Monopolistic completion market
5 AR = MR = P = MC E Oligopoly
15.
1 Commercial Bank A Exim Bank
2 Credit creation B 1982
3 UTI C Commercial Bank
4 Foreign trade D Discounting bills
5 EXIM Bank E Small investment
16.
1 Creation of utility A Prime factor
2 Indivisible factor B Monopoly
3 Electricity of Supply C Loss of Borrowers
4 Price discrimination D Increasing returns
5 Deflation E Production
17.
1 Unitary elastic DD curve A LAC curve
2 Micro Economics B Marshall
3 Skimming price C High price
4 Principles of economics D Price theory
5 Planned curve E Rectangular hyperbola
PREVIOUS PAPER’S & MTP’S BITS

FUNDAMENTALS OF ECONOMICS
JUNE 2017
1.
(a) Choose the correct answer from the given four alternatives. 20 x 1 = 20M
(i) Wealth was defined by
(c) Robbins (d) Jacob
(ii) Income minus Savings is equal to ______
(iii) ______ means the desire backed by the necessary purchasing power.
(iv) If the proportionate change in the supply is equal to the proportionate change in price, it
is said to be ______ supply.
(a) Unitary Elastic (b) Perfectly Inelastic
122
(c) Perfectly Elastic (d) Relatively Inelastic
(v) Production creates _____ utility.
(a) Place (b) Time (c) Form (d) Possession
(vi) Law of variable proportions was developed by _____
(a) Alfred Marshall (b) Adam Smith (c) Robbins (d) Jacob
(vii) The average ____ and output have inverse functional relationship.
(a) Fixed cost (b) Variable cost (c) Marginal cost (d) Total Cost
(viii) Economies of scales are divided into ____ types.
(a) 2 (b) 3 (c) 4 (d) 5
(ix) On the basis of competition, markets are classified into ____ types.
(a) 2 (b) 3 (c) 4 (d) 5
(x) ____ means absence of competition.
(a) Monopoly (b) Perfect (c) Imperfect (d) Oligopoly
(xi) The rate at which the commercial banks borrow from the RBI is called as ____
(a) REPO (b) PLR (c) BPLR (d) Bank Rate
(xii) In a competitive market, _____ is the price maker.
(a) firm (b) industry (c) consumer (d) trade association
(xiii) Long-run equilibrium price is known as _____
(a) Market price(b) Reserve Price (c) Normal Price (d) Support price
(xiv) “Money is what money does”. This definition was given by _____
(a) Adam Smith (b) Walker (c) Robbins (d) Robertson
(xv) The ____ states that bad money drives good money out of circulation.
(a) Law of Demand (b) Law of Supply
(c) Gresham’s Law (d) Demand Schedule
(xvi) ____ account can be opened only by businessmen.
(a) Current (b) Fixed Deposit
(c) Recurring Deposit (d) Time Deposit
(xvii) ____ is a qualitative credit control instrument used by the Central Bank.
(a) Bank Rate Policy (b) Moral Suasion
(c) Open Market Operations (d) CCR
(xviii) ____ was established as the apex bank for industrial credit.
(a) IDBI (b) ICICI (c) EXIM Bank (d) NABARD
(xix) Financial markets are classified into Money Market and ____
(a) Bullion Market (b) Capital Market (c) Stock Market (d) National
Market
(xx) Commercial Paper was introduced in Indian money market in January ____
(a) 1990 (b) 1980 (c) 1970 (d) 1960
(b) Match the following: 5x1=5

(i) Acceptance of Deposit (a) Fixed Factor
(ii) Law of Demand (b) Monopoly
(iii) Land (c) Commercial Bank
(iv) Price Discrimination (d) Treasury Bills
(v) Money Market (e) Alfred Marshall
(c) State whether the following statements are True or False: 5x1=5
(i) Production function expresses the relationship between the physical inputs and physical
output of a firm for a given state of technology.
(ii) Public expenditure comes under the monetary policy.
(iii) Demand Deposits consist of Fixed Deposits and Recurring Deposits.
(iv) Macro – Economics is also called as Income and Employment Theory.
(v) The Price Demand curve slopes downwards from left to right.
123
MTP – 1 :: JUNE 2017
1.
(a)Choose the correct answer from the given four alternatives. 20 x 1 = 20M
1. Normative Economic theory deals with _______________
(a) What to produce (b) How to produce
2. Nature of PPF curve is
(a) Convex to the origin (b) Concave to the origin
(c) Both (d) None
3. If an economy is working at the point left to PPF curve that shows _______________
(a) Full employment (b) Unemployment
(c) Excess production (d) None of the above
4. Micro economic theory deals with _____________.
(a) Economy as a whole (b) Individual units
(c) Economic growth (d) All of the above
5. Luxury goods have _______________ degree of elasticity.
(a) High (b) Low (c) Moderate (d) None
6. Price elasticity demand of product will be more, if it _____________________

(a) Has no substitutes (b) Has a number of substitutes
(c) Is an item of necessity (d) Is a life saving product
7. An increase in price will result in an increase in total revenue if________________
(a) Percentage change in quantity demanded is greater than the percentage change in
price
(b) Percentage change in quantity demanded is less than the percentage change in price
(c) Percentage change in quantity demanded is equal to the percentage change in price
(d) None of the above
8. Returns to a variable factor operates in _______________
(a) Short run (b) Long run (c) either 'a' or 'b' (d) neither 'a'
nor 'b'
9. All factors of production become variable in ________________.
(a) Medium run (b) Short run (c) Long run (d) None of the above
10. A rational producer will operate in ________________
(a) Stage I (b) Stage II (c) Stage III (d) All of the above
11. Why does the Law of Increasing Returns operate?
(a) Full use of fixed indivisible factors (b) Efficiency of variable
factors
(c) Need to reach the right combination (d) All the above
12. Which of the following is/are the essential features of the market
(a) Buyers (b) Sellers (c) Price (d) All the above
13. In the long run price is governed by __________________.
(a) Cost of production (b) Demand- Supply forces
(c) Marginal utility (d) None of the above
14. Which of these is/are associated with monopolistic competitive market
(a) Product differentiation (b) Homogeneous product
(c) Normal in short run (d) Single buyer
15. Optional money is a __________________
(a) Legal tender money (b) Non-legal tender money
(c) Limited legal tender money (d) Full bodied money
16. Which of these would lead to fall in demand for money?
(a) Inflation (b) Increase in real income
(c) Increase in real rate of interest (d) Increase in wealth
124
17. Which of these is near money?
(a) Bills of exchange (b) Savings Bond
(c) Gilt edged securities (d) All of these
18. Which is the apex bank for agricultural credit in India
(a) RBI (b) SIDBI (c) NABARD (d) IDBI
19. Manipulation in CRR enables the RBI to ________________
(a) Influence the lending ability of the commercial banks
(b) Check unemployment growth (c) Check poverty (d) Increase GDP
20. FERA has been replaced by __________________
(a) FINA (b) FEMA (c) FENA (d) MRTP

(i) Commercial Banks (a) Duopoly
(ii) Deflation (b) Average Cost
(iii) Two Firms (c) Discounting Bills
(iv) Land (d) Loss of Borrowers
(v) AFC + AVC (e) Fixed Factor
Answers: (i) C (ii) D (iii) A (iv) E (v) B
1. In perfect market AR=MR curve is parallel to X-axis. (True)
2. When TP is maximum, then AP is zero. (False)
3. PPC is also called PPF. (True)
4. Value of Paradox is depicted by law of demand. (False)
5. Money is treated as means of trade and commerce. (True)
MTP – 2 :: JUNE 2017
1.
(a) Choose the correct answer from the given four alternatives. 20 x 1 = 20M
1. Law of demand, there is a __________________ relationship between price and demand.
(a) Inverse (b) How to produce
2. The supply function of product ‘x’ is given as, Sx = 5px+3. Where px stands for price. The
quantity supplied corresponding to price 2 will be ______________
(a) 10 (b) 13 (c) 16 (d) 18
3. Which of the following is not a factor in market supply of a product?
(a) Cost of production (b) Number of buyers
(c) Market price of the product (d) Price of related products
4. Money market deals with _____________.
(a) Short term credit (b) Long term credit
(c) Both a & b (d) None of the above
5. Certificate of deposits are issued by the banks to ___________________.
(a) Individual (b) Companies (c) P.S.U.s (d) All of the above
6. Generally commercial bills are prepared for the period of __________________ days
(a) 90 (b) 180 (c) 360 (d) 365
7. Scarcity definition was given by ________________
(a) Adam Smith (b) Alfred Marshall (c) Robbins (d) Samuelson
8. Repo transactions means
(a) Sale of securities by the holder to the investor with the agreement to purchase them at
a predetermined rate and date.
(b) Sale of securities by the holder to the investor with the agreement to resell them at a pre-
determined rate and date.
125
purchase them at the prevailing rate and date.
(d) Sale of securities by the holder to the investor to the investor with the agreement to
purchase them at market driven rate.
9. EXIM Bank is authorized to raise loan from ________________.
(a) Reserve Bank of India (b) Government of India
(c) International Market (d) Trading activities
10. Which of these affects the demand for money?
(a) Real Income (b) Price level (c) Rate of Interest (d) All of the above
11. Which of the following function does money serve when used to measure the prices of
different goods and services?
(a) Store of value (b) Medium of exchange (c) Standard of value (d) Display of power
12. Bonds and Government Securities refer to ___________________ money.
(a) Near (b) Call (c) Optional (d) None of the above
13. A firm that makes profit in excess of normal profit is earning __________________.
(a) Economic Profit (b) Costing Profit (c) Real Profit (d) Super normal profit
14. In the long run a firm in perfect competition earns ____________________
(a) Normal profit only (b) Abnormal profit
(c) Average profit (d) 8.33% of capital employed
15. Variable factor means those factors of production
(a) Which can be only charged in the long run
(b) Which can be changed in the short run
(c) Which can never be changed (d) Any of the above
16. What is the maximum point of TP ____________
(a) When AP becomes zero (b) When MP becomes zero
(c) At the intersecting point of AP & MP (d) None of these
17. Identify the correct statement.
(a) AP is at its maximum when MP=AP
(b) Laws of increasing returns to scale relates to the effect of changes in factor proportion.
(c) Economies of scale arise only because indivisibilities of factor proportions
(d) All the statements are correct
18. Human wants are
(a) limited (b) unlimited (c) undefined (d) none
19. Which of these will have highly inelastic supply
(a) Perishable goods (b) Consumer durables
(c) Luxury goods (d) All of these
20. Any point beyond PPF is __________________
(a) attainable (b) unattainable
(c) Both ‘a’ & ‘b’ together (d) Either ‘a’ or ‘b’

(i) Principles of Economics (a) Keynes
(ii) Banks (b) Marshall
(iii) Macro Economics (c) Movement of DD Curve
(iv) Fiscal Policy (d) Credit Creation
(v) Contraction of Demand (e) Public Debt
Answers: (i) B (ii) D (iii) A (iv) E (v) C
1. Price discrimination is possible due to elasticity (True)
2. The supply curve in case of land is parallel to X-axis (False)
3. There is an inverse relationship between income and demand. (False)
4. Railways is an example of perfect market. (False)
5. When MC=MR the firm will get maximum profits. (True)
126

Fundamentals of Economics (60 Copies)

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STUDY NOTE 1

BASIC CONCEPTS OF ECONOMICS

Definition and Scope of Economics:

Subject Matter of Economics:

Wants Efforts Satisfaction

(a) Land (b) Labour (c) Capital (d) Organization

(a) Micro Distribution:

(b) Macro Distribution:

The definitions of economics can be classified into four categories.

1. Explain about Wealth definition?

2. Explain about welfare definition?

Important Features of Welfare Definitions:

3. Explain about scarcity definition or Robbin’s definition?

Superiority of Robbins definition:

4. Explain about Growth Definition?

Distinguish between Traditional Approach and modern approach relating to scope of

Traditional • Economics is a social science.

5. Distinguish between micro and macro economics?

Scope of micro economics

Product pricing Factor pricing Theory of Economic welfare

Importance of Micro Economics

Scope of Macro Economics

Scope of Macro Economics

Theory of Income, Theory of Economic

Theory of consumption Theory of Investment

Theory of fluctuation (or)

The different between Micro Economics and Macro Economics

Micro Economics Macro Economics

6. State whether the economics is science or Art?

Difference between science and Art:

7. State whether the economics is positive or normative science?

Economics as a Normative Science:

8. Distinguish between Deductive method and Inductive method?

In spite of the advantages, it has some limitations.

9. Explain about the central problems of all economies?

For whom to produce?

Few Fundamental Concepts

10. Define the wealth and its types?

(b) National Wealth:

11. Explain the relationship between wealth and welfare?

12. What is money and state its constituents?

When some commodities used as a medium of exchange by custom. It is called customary

Constituents of Money Supply:

Function of the Market:

14. What is meant by investment and its types?

Ans: Investment: An increasing the capital stock is called Investment.

(b) Portfolio Investment:

It is savings that are invested:

• Note: if there is foreign investment then S≠ I.

15. What is production and what are the factors of production?

16. What is consumption and its determination?

17. Relationship between income and wealth?

Wealth and Income:

18. Explain about consumer’s surplus?

C.S. = Willing Price – Actual Price

19. Explain about the law of Diminishing marginal utility.

Concepts in this law:

𝑀𝑈𝑛 = 𝑇𝑈𝑛 − 𝑇𝑈𝑛−1

Units Total Marginal

20. What is demand forecasting and state its methods?

Methods of Demand forecasting:

1. Expert Opinion Method –

2. Survey of buyers intentions –